Pension Finance Book

Preface     xv
Investment Assets Held by Pension Funds     1
Money-market securities     1
Bonds and loans     5
Shares     10
Collective investment vehicles     13
Unit trusts and open-ended investment vehicles     13
Investment trusts     15
Insurance products     16
Exchange-traded funds and guaranteed growth funds     17
Real assets     18
Property     18
Land     21
Collectibles     21
Derivatives     22
Forwards and futures     22
Options, warrants and convertibles     26
Swaps     32
Forward-rate agreements     36
Synthetic securities     37
Alternative investments     37
Public market strategies     38
Private market or private equity strategies     44
Natural resources     47
Socially responsible investment     48
Global custody     49
Different asset characteristics and uses     51
Asset characteristics     51
Asset uses     52
Conclusions     61
Questions     61
Standard deviation, value-at-risk and correlation     62
References     64
Personal Finance: The Allocation of Personal Wealth to Different Asset Classes     67
Introduction     67
Modelling the allocation of personal wealth to different asset classes     70
Conclusions     74
Questions     75
References     76
Corporate Pension Finance     77
The valuation of pension liabilities: differences between the actuarial and economic approaches     77
Pensions and the company balance sheet: differences between the accounting and economic approaches     79
The asset allocation of the pension fund     83
A fully funded pension fund     84
An underfunded pension fund     87
A pension fund with liabilities linked to earnings growth     87
An insured pension fund     88
The relationship between the pension fund and the sponsoring company's profitability, credit rating and share price     91
Profitability     91
Credit rating     92
Share price     93
Conclusions     96
Questions     98
References     99
Defined Contribution Pension Schemes - The Accumulation Phase     101
The optimal design of DC schemes during the accumulation phase     101
Stochastic pension scheme design     102
Risk factors     104
Control variables     111
Simulation output     114
Choosing the optimal asset-allocation strategy     122
The trade-off between risk and contribution rates     123
Charges     124
Types of charges     124
Reduction in yield     125
Reduction in contributions     127
Changing charging structures and the impact of hidden charges     130
Persistency     132
Persistency rates     132
Adjusting reported charges for policy lapses     133
Conclusions     134
Questions     135
Charges     137
Reduction in yield     138
Reduction in contributions     139
Adjusting for lapse rates     140
References     142
Defined Contribution Pension Schemes - The Distribution Phase     145
Annuities     145
Purchase arrangements     146
Coverage     146
Variations      147
Other features     147
Payment terms     148
Decomposition of annuity charges     152
Mortality drag     159
The optimal design of DC schemes during the distribution phase     161
Alternative distribution programmes     162
Stochastic pension scheme design     166
Simulation output     174
Impact of poor health     183
The annuitisation decision     183
Conclusions     187
Questions     188
References     189
Defined Benefit Pension Schemes     191
Types of defined benefit scheme     191
Defined benefit liabilities     194
The option composition of pension schemes     196
Valuing the options     199
The pension scheme preferences of members, sponsors and fund managers     206
Conclusions     208
Questions     209
References     209
Pension Fund Management     211
The role of a pension fund     211
The functions of a pension fund manager     217
Fund management styles     218
Different fund management strategies for defined benefit and defined contribution schemes      220
The fund manager's relationship with the trustees     224
Determining the trustees' objectives and constraints     224
Determining the trustees' benchmark portfolio     225
Investment-risk budgeting     231
Passive fund management     233
Active fund management     237
Active share-fund management     238
Active bond-fund management     243
Mixed active-passive fund management     248
Asset-liability management     250
Managing surplus risk     253
Managing contribution risk     259
Key ALM strategies     260
The Myners Review of institutional investment     274
Conclusions     280
Questions     281
Investment-objectives questionnaire     283
Derivation of the optimal contribution rate and asset allocation in a defined benefit pension fund     287
References     290
Pension Fund Performance Measurement and Attribution     293
Ex post returns     293
Benchmarks of comparison for actively managed funds     296
Risk-adjusted measures of portfolio performance for actively managed funds     299
Performance measures based on risk-adjusted excess returns     300
Performance measures based on alpha     302
Performance attribution for actively managed funds     305
Liability-driven performance attribution     310
Realised investment performance     314
Investment performance of DC funds     314
The investment performance of DB funds     317
Performance-related fund management fees     324
How frequently should fund managers be assessed?     326
Conclusions     328
Questions     329
Deriving the power function     330
References     332
Risk Management in Pension Funds     335
The objective of hedging     335
Hedging with futures     336
Hedging with stock-index futures     338
Hedging with bond futures     340
Hedging with currency futures     343
Hedging with options     344
Hedging with individual stock options     344
Hedging with stock-index options     350
Hedging with bond options     351
Hedging with currency options     351
Hedging with swaps     352
Hedging longevity risk     354
Longevity risk      354
A new hedging instrument: longevity (or survivor) bonds     358
The implications of longevity bonds     358
Mortality-linked derivatives     362
Conclusions     363
Questions     363
References     364
Pension Fund Insurance     367
The Pension Protection Fund (PPF)     367
What the Pension Protection Fund can learn from other financial institutions and compensation schemes     368
The financial regulation of banks     369
The financial regulation of life assurers     374
Financial Services Compensation Scheme     382
The financial regulation of pension funds     383
Pension Benefit Guaranty Corporation (PBGC)     388
The risks facing the PPF     390
Moral hazard     391
Adverse selection: bad drives out good     392
Systemic risk     392
Political risk     394
Dealing with these risks     394
An equity claim against the sponsoring company     395
A maximum payout     395
Risk-based premiums linked to the level of underfunding     395
A funding standard for schemes     396
Close supervision and the public exposure of companies that underfund their schemes     397
Comment     398
Conclusions     398
Questions     399
The Marcus (1987) and Vanderhei (1990) Models     400
References     408
Financial Arithmetic     411
Future values: single payments     411
Simple interest     411
Compound interest: annual compounding     412
Compound interest: more frequent compounding     412
Flat and effective rates of interest     414
Present values: single payments     414
Present values: annual discounting     415
Present values: more frequent discounting     415
Future values: multiple payments     416
Irregular payments     416
Regular payments     417
Present values: multiple payments     418
Irregular payments     418
Regular payments: annual payments with annual discounting     419
Perpetuities     419
Rates of return     420
Single-period rate of return     420
Internal rate of return or money-weighted rate of return     421
Time-weighted rate of return or geometric mean rate of return     423
Yields and Yields Curves     425
Yields     425
Current yield     425
Yield to maturity     425
Yield curves     427
The yield to maturity yield curve     427
The coupon yield curve     428
The par (or swap) yield curve     429
The spot (or zero-coupon) yield curve     430
The forward yield curve     433
The annuity yield curve     436
Rolling yield curve     437
Duration and Convexity     439
Duration     439
Convexity     446
Index     451