Financial Planning & Investment Strategies Flashcards

A plan sponsor decides to transition from an active equity manager to a passive index fund. The MAIN cost to quantify during this transition is:

Answer: Market impact and transaction costs during the portfolio liquidation

Manager transitions incur market impact costs (price movement from large trades) and explicit transaction costs that can significantly offset fee savings from switching to passive.

Which asset-liability management (ALM) technique freezes pension liability growth by closing the plan to new entrants while honoring accrued benefits?

Answer: Soft freeze

A soft freeze closes the plan to new participants but allows existing participants to continue accruing benefits, limiting but not eliminating future liability growth.

The primary purpose of a stable value fund in a defined contribution plan is to:

Answer: Offer capital preservation with returns above money market rates via book-value accounting

Stable value funds use insurance wrappers or bank contracts to maintain book value accounting, delivering bond-like returns without mark-to-market volatility.

A pension plan's investment committee is evaluating two managers with identical 10-year returns. Manager A has a tracking error of 2% and Manager B has a tracking error of 8%. All else equal, which manager demonstrates more consistent value-add?

Answer: Manager A, because lower tracking error with equal returns implies a higher information ratio

Manager A's lower tracking error with identical returns produces a higher information ratio, indicating more consistent and efficient active management.

Under the DOL's investment advice regulations, a pension consultant providing individualized investment recommendations to a plan must act as a:

Answer: Fiduciary acting in the plan's and participants' best interest

The DOL's rules classify individualized investment recommendations to plans as fiduciary advice, requiring the advisor to act in participants' best interests.

Which risk measure captures the average loss in the worst 5% of outcomes for a pension portfolio?

Answer: Conditional Value at Risk (CVaR) / Expected Shortfall

CVaR (also called Expected Shortfall) measures the expected loss given that the loss exceeds the VaR threshold, capturing tail risk beyond the VaR cutoff.

A plan sponsor wants to reduce the pension plan's balance sheet volatility recognized under ASC 715. Which strategy MOST directly achieves this?

Answer: Implementing a liability-driven investment strategy to match asset and liability movements

LDI reduces balance sheet volatility by aligning asset duration with liability duration so that assets and liabilities move together when discount rates change.