Insurance consultant

Selecting a portfolio strategy that is consistent with the investment objectives and investment policy guidelines of the client or institution is the third step in the investment management process. Portfolio strategies can be classified as either active or passive.
An active portfolio strategy uses available information and forecast- ing techniques to seek a better performance than a portfolio that is sim- ply diversified broadly. Essential to all active strategies are expectations about the factors that have been found to influence the performance of an asset class. For example, with active common stock strategies this may include forecasts of future earnings, dividends, or price-earnings ratios. With bond portfolios that are actively managed, expectations may involve forecasts of future interest rates and sector spreads. Active portfolio strategies involving foreign securities may require forecasts of local interest rates and exchange rates.
A passive portfolio strategy involves minimal expectational input, and instead relies on diversification to match the performance of some market index. In effect, a passive strategy assumes that the marketplace will reflect all available information in the price paid for securities. Between these extremes of active and passive strategies, several strategies have sprung up that have elements of both. For example, the core of a portfolio may be passively managed with the balance actively managed.
In the bond area, several strategies classified as structured portfolio strategies have been commonly used. A structured portfolio strategy is one in which a portfolio is designed to achieve the performance of some predetermined liabilities that must be paid out. These strategies are frequently used when trying to match the funds received from an investment portfolio to the future liabilities that must be paid.
Given the choice among active and passive management, which should be selected? The answer depends on (1) the client’s or money manager’s view of how “price-efficient” the market is, (2) the client’s risk tolerance, and (3) the nature of the client’s liabilities. By market- place price efficiency we mean how difficult it would be to earn a greater return than passive management after adjusting for the risk associated with a strategy and the transaction costs associated with implementing that strategy.

Tax considerations are important for several reasons. First, in the United States, certain institutional investors such as pen- sion funds, endowments, and foundations are exempt from federal income taxation. Consequently, the assets in which they invest will not be those that are tax-advantaged investments. Second, there are tax factors that must be incorporated into the investment policy. For example, while a pension fund might be tax-exempt, there may be certain assets or the use of some investment vehicles in which it invests whose earnings may be taxed.
Generally accepted accounting principles (GAAP) and regulatory accounting principles (RAP) are important considerations in developing investment policies. An excellent example is a defined benefit plan for a corporation. GAAP specifies that a corporate pension fund’s surplus is equal to the difference between the market value of the assets and the present value of the liabilities. If the surplus is negative, the corporate sponsor must record the negative balance as a liability on its balance sheet. Consequently, in establishing its investment policies, recognition must be given to the volatility of the market value of the fund’s portfolio relative to the volatility of the present value of the liabilities.

There    are    many    types    of    regulatory    constraints. These involve constraints on the asset classes that are permissible and concentration limits on investments. Moreover, in making the asset allcation decision, consideration must be given to any risk-based capital requirements. For depository institutions and insurance companies, the amount of statutory capital required is related to the quality of the assets in which the institution has invested. There are two types of risk- based capital requirements: credit risk-based capital requirements and interest rate-risk based capital requirements. The former relates statutory capital requirements to the credit-risk associated with the assets in the portfolio. The greater the credit risk, the greater the statutory capital required. Interest rate-risk based capital requirements relate the statutory capital to how sensitive the asset or portfolio is to changes in interest rates. The greater the sensitivity, the higher the statutory capital required.

Examples    of    client-imposed    constraints    would be restrictions that specify the types of securities in which a manager may invest and concentration limits on how much or little may be invested in a particular asset class or in a particular issuer. Where the objective is to meet the performance of a particular market or customized benchmark, there may be a restriction as to the degree to which the manager may deviate from some key characteristics of the benchmark.

Once a portfolio strategy is selected, the next step is to select the specific assets to be included in the portfolio. It is in this phase of the investment management process that the investor attempts to construct an efficient portfolio. An efficient portfolio is one that provides the greatest expected return for a given level of risk or, equivalently, the lowest risk for a given expected return.

There are some institutional investors that make the asset allocation decision based purely on their understanding of the risk-return characteristics of the various asset classes and expected returns. The asset allocation will take into consideration any investment constraints or restrictions. Asset allocation models are commercially available for assisting those individuals responsible for making this decision.
In the development of an investment policy, the following factors must be considered:
Client constraints   Regulatory constraints   Tax and accounting issues

Critical to the success of Ralph’s efforts to build a value-creation focus into EG was the need to upgrade the role of the CFO. It was clear to Ralph that the link between business strategy and financial strategy was becoming tighter. Corporate strategies, which are designed to create an advantage in the market for corporate control and financial markets, are by definition intertwined with financial considerations. Furthermore, it was going to take a lot of work to make managing value an important element of EG’s strategy and management approaches. Ralph would need a strong executive who would be able to help him push this through.
EG financial officers had been focused on running the treasury operation, producing financial reports, and negotiating the occasional deal. Ralph needed much more, and since his current CFO was due to retire at the end of the year, he felt this was a perfect opportunity to redefine the role. Ralph’s concept was to create a position that would blend corporate strategy and finance responsibilities. The officer would act as a bridge between the strategic/operating focus of the division heads and the financial requirements of the corporation and its investors. Ralph drafted a job description for this position, which in EG’s case would carry the title of executive vice president (EVP) for corporate strategy and finance. The EVP would act as a kind of ‘’super CFO” and take the lead in developing a value-creating corporate strategy for EG, as well as to work with Ralph and the division heads to build a value-management capability throughout the organization.

Crucial to both flow and technical analysis is the idea that financial markets are not in fact inherently efficient and that the past can in fact impact the future. With flow analysis, one is dealing with trends in order flow. With technical analysis, one is analysing past pricing to make predictions about the future. At its most basic, technical analysis uses such concepts as “support” and “resistance” to denote points of dynamic market tension between supply and demand for an exchange rate, equity, bond or commodity. At a more sophisticated level, technical analysis relies on patterns in mathematics to suggest they may be reproduced in market pricing. Fibonacci, Elliott Wave and Gann analysis are examples of these.
“Charting” remains a controversial subject for some within the financial and academic communities who appear to regard it as little more than voodoo. In the real world of trading, hedging and investing however, nothing counts except results. Unlike in the economic world where the quality of the story is seen as important, almost irrespective of its accuracy, for traders, investors and corporations the bottom line is the bottom line. To that end, while classical economics has failed to explain short-term exchange rate moves on a sustained basis, flow and technical analysis have stepped into the void. Just as in economics, there are “good” and “bad” chartists or technical analysts. The profession of technical analysis however has consistently outperformed the returns generated by random walk theory and frequently also those by economists. In analysing exchange rates, currency market practitioners who do not use technical analysis in addition to fundamental analysis are hampering their own ability to produce consistently high returns.

As barriers to trade and capital have broken down in the last two decades, so capital flows have become increasingly important, both in terms of their impact on the economy and in turn on the exchange rate. At USD1.2 trillion in daily volume, the currency markets trade the equivalent of annual global merchandise trade every day of the year. Like any market, the currency market is affected by demand and supply, which in this case is reflected by order flow. It has been found that tracking order flow can provide both a useful explanation of past price activity in currency markets and — more importantly — can be used as a predictor of future price action. The basic premise behind this is that changes in order flow, if sufficiently large, can have predictable and sustainable impact in the currency markets in terms of price action. There are several short- and medium-term flow indicators which the reader should be aware of. Short-term flow data:
The IMM Commitments of Traders report Medium-term flow data:
US Treasury “TIC” capital flow report
Euro-zone portfolio report
IMF quarterly report on emerging market financing
IIF capital flows report
In addition to flow data provided by the trading exchanges as in the case of the IMM and by official sources as with the TIC and Euro-zone reports, there are also proprietary flow models created by commercial and investment banks to analyse client flows going through the bank’s currency dealing rooms.
Order flow/sentiment models
Flow data and models provide direct evidence of the effect of order flow on market pricing. A more indirect but no less useful to way to do that is to look at market sentiment indicators such as:
Option risk reversals
These are a very useful gauge of the market’s “skew” or bias towards an exchange rate. Analysing risk reversal trends over time relative to the spot rate may allow one to make predictions as to future spot rates based on the risk reversal.

Classical economics has sought and failed to explain short-term exchange rate moves on a consistent basis. Currency economics is an attempt to fine tune economic theory to the practical relevance of the currency market. Broadly speaking, it seeks to analyse those aspects of the economy that are relevant to the exchange rate value, such as:
Trends within the balance of payments, including the current and capital accounts;
The accounting identity for economic adjustment ( S ? I = X ? M );
The Real Effective Exchange Rate (REER) and the external balance;
Relative productivity measures.
Naturally, all other aspects of the economy should be considered such as growth, inflation and so forth, but the ones mentioned above are the key indicators relevant for our purpose of currency analysis and strategy. Growth per se does not make a currency rise or fall on a consistent basis. Currency market practitioners, while keeping an eye on other parts of the economy as well, should seek to focus primarily on those specific aspects of the economy that affect the exchange rate.