Background information: ABC Superannuation Fund

ABC Superannuation Fund (ABC) is a scheme that was originally only available to state public servants. It has two parts:
- a defined benefit (DB) scheme
- a defined contribution (DC) scheme.

The ABC DB scheme was closed to new members a number of years ago and is currently in ‘run-off' mode. The scheme was only ever available to public servants.

In a DB scheme, the fund essentially bears investment risk rather than investors. Investors receive a return at retirement in the form of a pension or a lump sum, based solely on salary and years served in the public service. As the final payment (or lump sum) is effectively guaranteed by the government, members are not provided with information regarding performance. Actuaries have calculated that ABC's DB scheme is marginally underfunded. At current rates of withdrawal, approximately 3% of the fund's capital is withdrawn each year and the fund will need to meet liabilities for the next 45-50 years. The average age of investors in the fund is 55, with the youngest 2% of members being age 40.

There are only a few DB schemes left in Australia and each scheme has a different member demographic base.

The DC scheme is popular with both current public servants and those past public servants who now work in the private sector. There are eight options available to members including a number of asset class specific options, a number of diversified options and a socially responsible investing (SRI) option. Almost 80% of DC members are invested in the ‘Balanced Fund', which also serves as the MySuper option. The average age of members in the Balanced Fund is 50, which is around 20 years above the average member age for other similar funds (peers). The average balance is $105,000, well above the average balance for peers, and the average salary of those members is $100,000 p.a., which is also well above the average salary of members in other Balanced Funds.

Most of the DC scheme's options, including the Balanced Fund option, have provided fairly competitive returns over the past five years. Nonetheless, in the aftermath of the global financial crisis (GFC), the trustees of the fund would like to undertake a full analysis of the DB scheme and the Balanced Fund option in the DC scheme to ensure that the funds are likely to meet members' expectations in the future. They are aware that, for example, the members invested in the Balanced Fund do not represent the average cohort in a Balanced Fund, thus their needs may be different. They believe that the funds have been too focused on achieving returns competitive to peers rather than providing long-term real returns or considering the true needs of members. As the other options in the DC scheme are small, they will be considered as a separate project after this one is completed.

Question

LO1: Analyse the processes involved in managing an investment portfolio.

(a) Analyse the objectives of the defined benefit fund in terms of the return requirements.
How do you think they could be improved?

(b) Analyse the objectives of the defined benefit fund in terms of risk management.
How do you think they could be improved?

(c) Propose two (2) new objectives for the defined benefit fund based on both return and risk requirements.

(d) Analyse the objectives of the balanced fund in terms of the return requirements.
How do you think they could be improved?

(e) Analyse the objectives of the balanced fund in terms of risk management.
How do you think they could be improved?

Question 1
LO1: Analyse the processes involved in managing an investment portfolio.
LO4: Assess manager selection and portfolio management styles.
(a) Evaluate the strengths and weaknesses of the current process to select investment managers. (4 marks)
(b) Explain how you would improve the process, focusing your discussion on the selection of managers for the equity portfolio. (4 marks)
(c) Provide a brief overview of what is meant by an ESG overlay to an investment process as well as whether any research is available to support the addition of this overlay to a manager's process? (5 marks)

Question 2
LO2: Explain the theoretical concepts underpinning investment management.
LO3: Apply the process of asset allocation and portfolio construction.
(a) The strategic asset allocation (SAA) of the balanced fund has been calculated using a mean variance optimiser with 10 years of past returns, volatility and correlation. As discussed in the IPS (Appendix 1), the SAA is recalculated every year using the past 10 years' data for the major benchmarks in each sector, subject to peer related constraints.
Discuss the merits or weaknesses of this approach, with reference to:
(i) the assumptions underlying the mean variance approach to asset allocation, and therefore underlying this approach.
(ii) the suitability of the data used, suggesting any changes you believe may be warranted.
(iii) the method of calculating asset allocation and the constraints used, suggesting any changes you believe may be warranted.
(b) (i) Briefly describe the impact of increasing inflation on the equity and fixed interest asset classes.
(ii) What investments and/or strategies may be available to hedge a fixed interest portfolio if the fund manager expects higher interest rates?
(c) The trustees are interested in behavioural finance but know very little about it. Explain how you think behavioural finance might impact each fund's asset allocation. What benefits could behavioural finance insights provide the trustees when setting the objectives and strategic asset allocation for the funds?

Question 3
LO3: Apply the process of asset allocation and portfolio construction.

(a) The trustees of ABC have now asked you to consider alternative approaches to asset allocation. Consider the strategic asset allocation (SAA) for the defined benefit fund (as set out in Appendix 2).
(i) Assess three (3) strengths and three (3) weaknesses of the current SAA, including the approach to setting the SAA and the ranges for each asset class.
(ii) Provide a rationale as to whether this allocation is appropriate given the objectives as they are currently expressed. (2 marks)
(iii) Is the SAA appropriate for the two new objectives you formulated in Question 1(c)? Explain why or why not. Recommend improvements that will increase the probability of your formulated objectives being reached.
(iv) Propose an alternative approach to setting the SAA for the defined benefit fund and discuss why you think it would be superior to the current approach. Provide reasons and evidence to support your view. (Include in your discussion theoretical underpinnings and frequency of review.)

(b) The asset allocation policy for the defined benefit fund is silent on the use of active asset allocation (AAA), which is an approach whereby the fund would vary asset allocation, rather than maintain a fixed or strategic asset allocation (SAA).
Discuss the benefits and disadvantages of the AAA approach in general.

(c) The trustees have asked you to also review the strategic asset allocation (SAA) for the balanced fund.
(i) Propose what you consider may be a more appropriate approach for determining the fund's SAA. Explain why your suggested approach is more appropriate.
(ii) Propose guidelines as to how often the SAA should be reviewed.
Note: Your answers to part (c) may include approaches previously considered in this assignment.

(d) The IC is concerned that the asset allocation bands are too wide and that the portfolio would benefit from reducing these bands and thereby having more frequent rebalancing.
Discuss the benefits and costs of moving to a more active re-balancing strategy.

(e) The IC wants to consider whether the portfolio would benefit from an additional allocation to alternatives, specifically hedge funds.
Discuss the role of hedge funds in a portfolio by providing the IC with a list of three hedge fund characteristics and explaining how these may alter the portfolio in terms of risk and return.

Attachment:- Investment Management.rar