I have problems grasping the concept of time horizons for institutional investors. Can anyone help? For PWM, time horizon is fairly straight-forward: The (first) time horizon is usually the time until the first major change in investor circumstances occurs, this could be retirement, children finishing college (and therefore not requiring payments), death of a wealthy relative and subsequent major inheritance etc. However, in all cases that I have encountered so far, the time horizon is a number that is actually stated somewhere in the problem description. For institutional investors, this is not always the case. As most of the institutions are going concerns with a supposedly eternal time horizon. There are no “changes in circumstances”, maybe a plan becomes underfunded or something like that, but an endowment will always face the same funding requirements; the circumstances CAN change, but this is usually not forseeable at IPS creation (i.e. firm that receives funding from endowment receives less money from other sources than previously => decrease in risk tolearance of endowment). For banks, especially, time horizon seems to depend on the maturities (or duration?) of the liability structure. I don’t see how this can be derived? Time horizons are “shorter” for non-life than life insurance companies, I know this has to do with shorter and less predictable cycles in the life of non-life contracts; but what does that have to do with time horizons? Assuming that average non-life contracts have cycles of 3 years, would that result in a time horizon of 3 years? Thanks, OA
Don’t try to out-think CFAI. Everything CAN change, but stick to the usual and look for something in the case that would indicate otherwise…thus I’d suggest time horizons of: Endowment/Foundation - Perpetuity, unless told otherwise Life Insurance Co - 20-40 years as it is the typical duration of their liabilities (this has shortened over time) Non-Life Insurance Co - 3-5 as typical underwriting cycle and would need to be matching. I think it is best to look at it from the perspective of Asset Liability Mgmt, you’re trying to match the duration of assets & liabilities, so this duration is essentially your time horizon.
for banks, time horizon is short to midterm
Oops, left out a few…yup banks should be <10 years in general The pension is the one that is going to be the hardest to generalize as it will likely be long term, but lots of other factors will play in (going concern, newly established plan, how young is the workforce, mix of active vs. retired, etc).
Thanks, Sponge and kblade.
i would just add that pension funds are primarily driven by the duration of their liabilities (i.e., “how young is the workforce, mix of active vs. retired” as mention by Sponge above), and not by going concern status. the going concern status just reinforces whether the company is viable enough to make expected payments. if they are close to bankruptcy, then of course it plays into time horizon directly.
but shouldnt time horizon be based on the fact that you expect the company to be a going concern? like for banks, a short-to-medium horizon implies they think they are going out of business in 10 years or less?
mike the short to medium time horizon refers to average duration of liabilities.
^^^ Exactly. When you jump from individual to institutional the time horizon is more closely linked to duration of liablities…otherwise you would expect every going concern’s horizon to be perpetuity.
mike0021 Wrote: ------------------------------------------------------- > but shouldnt time horizon be based on the fact > that you expect the company to be a going concern? > like for banks, a short-to-medium horizon implies > they think they are going out of business in 10 > years or less? Banks are a little different than the others. They use their security portfolio as a source of liquidity because they liabilities are deposit (short term) and their assets are loans (usually longer term). This leads to a A/L mismatch. They balance it with their portfolio. They also have a bunch of regulation to content with as well as needing to “get at” the portfolio quickly if demand for loans increases or withdrawal of deposits increases (both are a cash need for the bank). That is how I understand it.
Hi guys, I have a question here. When we input data for return requirements and time horizon for institutional investors, should we put in a hard number? For time horizon, do we also input hard numbers depending ont he institution? or just say going concern??
sparty419 Wrote: ------------------------------------------------------- > Hi guys, I have a question here. When we input > data for return requirements and time horizon for > institutional investors, should we put in a hard > number? For time horizon, do we also input hard > numbers depending ont he institution? or just say > going concern?? Required Return It depends what they’re asking you to do. “Formulate” means just say what they need to “provide a return sufficient” for, if they say “calculate” than you better throw out some numbers. Time Horizon XYZ has a “long term” time horizon because the (plan is a going concern and average age of employees is 35…) (endowment has an infinite time horizon) (surplus portfolio must provide for long-term growth) etc.