Investment Skill Is a Rare Commodity

Administrators of pension and endowment funds might be surprised to find themselves referred to as investment engineers. Yet these particular institutional investors (who are often called "plan sponsors") face the complex problem of efficiently allocating their assets among various investment managers so as to best achieve their stated investment objectives. The disciplined process through which this manager "structuring" problem can best be resolved is analogous to an engineer designing a building or a machine.

When plan sponsors choose to invest in a particular asset class, especially a well-defined and liquid one such as the US common stock market, they typically choose a market index to characterize the expected return and risk opportunities of the asset class and to serve as a benchmark against which to evaluate the subsequent performance of their investments. In this context, the selected market index is called an asset class target. For example, a plan sponsor might specify the Standard & Poor's 500 and the Solomon Brothers Broad Bond Index as the asset class targets for its US common stock and fixed-income investments, respectively.

Plan sponsors rarely opt to conduct all of their investment in an asset class on a strictly passive basis. Instead, they typically hire a number of active investment managers. In aggregate, these active managers are expected to exceed the performance of the asset class target on a risk-adjusted basis.

For various reasons most active investment managers pursue distinct investment styles, focusing their efforts in particular niches of the marketplace. For example, some common stock managers concentrate on small capitalization growth stocks, whereas some bond managers invest only in mortgage-backed securities.

Just as an investment manager will diversify within a portfolio to avoid unintended risks, a plan sponsor will diversify across investment managers. This manager diversification reduces the possibility that one manager's mistakes will seriously harm the plan sponsor's total portfolio. Further, it avoids the risk that the total portfolio will be excessively exposed to the results of a specific investment style.

The goal of efficient style diversification is to be style neutral relative to the asset class target. That is, in aggregate, the investment styles of a plan sponsor's managers should exhibit exposures to factors of risk and return similar to those of the asset class target.

Words you may need:

endowment fund благотворительный фонд

analogous adj аналогичный

asset class класс актива

market index рыночный индекс

benchmark n база, ориентир, отправная точка

asset class target цель по классу актива

opt v выбирать

in aggregate в целом

on a risk-adjusted basis с учетом риска

small capitalization growth stocks акции мелких быстрорастущих компаний

exposed to the results (зд.) зависеть от результатов

exposure n (зд.) подверженность

Investment Trusts

Small shareholders who do not have enough money to invest in a wide-range portfolio buy shares in investment trusts.

Investment trust is a public corporate body which invests funds in a wide range of stocks and shares, thus "spreading the risk" more effectively than could be achieved by an individual investor with much smaller funds. The capital of the investment trust is derived mainly from public issues of debentures, preference shares and ordinary shares, which are quoted on the stock exchanges.

Investment trusts can be of two types. Open-end investment fund is an investment fund that is open in the sense that it issues new shares every time that it receives new money from investors – unlike a closed-end investment fund, which issues a limited number of shares that are then traded only in a secondary market. Closed-end investment companies do not stand ready to purchase their own shares whenever one of their owners decides to sell them. Instead their shares are traded either on an organized exchange or in the over-the-counter market.

Most closed-end funds have unlimited lives. Dividends and interest received by a closed-end fund from the securities in its portfolio are paid out to its shareholders.

However, most funds allow the reinvestment of such payments.

Besides, there are so called Real Estate Investment Funds. REIFs have existed for over 30 years. They are essentially (although not legally) closed-end investment companies that invest in real estate instead of financial assets. Similar to true investment companies, as long as 95% of their income is distributed to shareholders, it is free from taxation. Further, at least 75% of their assets and income must be derived from real estate equity or mortgages. REIFs must also have at least 100 shareholders. Their portfolios must be diversified, and no more than 30% of their income may come from selling properties held for less than four years. (This last requirement is designed to prevent REIFs from becoming vehicles for real estate speculation.)

REIFs engage in a common financial intermediation process known as securitization. A REIF manager converts (securitizes) properties into financial assets by purchasing properties for the REIF. In order to finance the purchases the REIF manager issues freely tradable ownership shares.

Words you may need:

derive v получать, извлекать

real estate investment fund учреждение, специализирующееся на инвестициях в недвижимость

securitization n «секьюритизация» (процесс повышения роли различных видов ценных бумаг как формы заимствований)