Actuarial Investments

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Actuarial Investments

• Shane Whelan
• L527

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So what is our approach to Actuarial Investment?

• Overview of perpective we wish to achieve before
  we treat each major capital market in turn

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The investor

• Begin always from viewpoint of Investor
• The basic investment objectives
• the highest possible return within acceptable
  level of risk
• understanding constraints (risk tolerance) of
  investor
• optimisation problem (of reward) subject to
  generally non-explicit constraints (the risk).
• The investor objectives are every bit as
  important as the investment opportunity.
• Reward and risk must be interpretated from the
  standpoint of the investor
• Typically actuaries advise long-term investors
• Pension funds, charities, life office with
  profits, shareholders funds, unit-linked funds,
  etc.

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Objectives of Investor

• Funds accumulated to meet liabilities
• Consider Nature of liabilities real, monetary.
• Term of liabilities
• Currency
• Uncertainty in timing, in amount.
• Surplus over liabilities (free assets)
• Legislation Regulation
• Taxation only net return matters
• Other

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Simplicity of Long-Term Investment

• Capital assets are bought for their promise of
  future income
• Three things matter when trying to evaluate this
  promise
• ...the amount of the future payoff
• ...the timing of the future payoff
• ...the certainty of the future payoff

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For Equities, Nobody Knows Out-turn

• If we speak frankly, we have to admit that our
  basis of knowledge for estimating the yields
  returns ten years hence of a railway, a copper
  mine, a textile factory, the goodwill of a patent
  medicine, an Atlantic liner, a building in the
  City of London amounts to little and sometimes to
  nothing
• Keynes, The General Theory of Employment,
  Interest, and Money (1936), IV, C 12.

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Investor Three Core Questions

• What return can realistically be expected from
  each investment type?
• What is the range of possibilities?
• What are the risks and how can I mitigate them?
• So any advice must be framed in these terms.

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Case Study

• Individual Providing for Own Pension - Handout
• - Whelan, S. (2002)
• Prudent Pension Planning
• Hibernian Investment Managers, Dublin. 43 pp.

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The Investment or Asset

• Old acronym of actuarial students used to
  consider investment attributes relative to the
  liabilities
• S
• Y
• S
• T
• E
• M
• T

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The Investment or Asset

• Old acronym of actuarial students used to
  consider investment attributes relative to the
  liabilities
• Security
• Yield
• Spread
• Term
• Exchange Rate
• Marketability
• Taxation

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The Different Asset Types

• Cash money-market instruments
• Government fixed interest
• Corporate fixed interest
• Index-linked bonds
• Equities
• Property
• Currency
• Derivative instruments constructed from the above
• Various Pooling Vehicles

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Basis of our knowledge of asset price behaviour

• Largely historic behaviour, wisely interpreted.
• Validity of past data to model the future
  difficult to assesswe know that, at a minimum,
  knowledge of past affects the future.
• So historic returns, their standard deviations
  and their correlation relationship with other key
  variables used at least as a starting point.
• Newer asset classes, e.g. index-linked stock,
  must guesstimate their properties.
• Taxation - generally use current code and rates.

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Riskier Assets Produce Higher Returns

• Comment