TOC
1. Insurance
- In reutrn for a premium, insurance offers customers financial compensation against various risks.
- premium: customers may continuously pay premiums but never make any claims
- Insurance firms are owned by shareholders or their policy holders.
- Insurance is “Float”
- Received upfront
- Investment and cash reserve
- Insurance is regulated by the FCA(UK), Solvency II framework (EU), FIO(US, Federal Insurance Office)
There exists asymmetric information in insurance market: negotiating parties have asymmetric information which is essential to the contracting process. And that results in adverse selection. Adverse selection occurs when some parties have the incentive to take advantage of their information edge and they become ‘representative’. In acticipating this, the insurance firms will increase the premium or limit the offer.
With moral hazard, if someone is insured, they may be more likely to ignore risks and be less careful. In anticipating this, insurance firms may increase the excess (the loss the policy holder bears before the pay-out from the insurance)
2. Pension
“Retirement money”
IN: current employers’ and employees’ regular payments
OUT: those who have retired
- If the “money” is not funded (like pensions for some public sector workers), the current inflow pays out directly, no accumulation.
- If the “money” is funded, then it can be invested to grow and be accumulated.
Pension has defined contribution: Pay-in (contribution) is fixed, but pay-out is not fixed, which depends on the return and
Pension funds investments
Considerations:
- Long-term liabilities
- Long-term stability
- Large float
A wide range of asset classes:
- Fixed income securities
- Equities
- Hedge funds
Pension fund governance and regulation
Purpose of governance: advising, monitoring
Trustees: Control the fund, possess knowledge of the funding and the investment of their assets.
3. Collective investment
Pooled money from a group of investors put into a range of investments.
- Open-ended collective investment
- Unit trusts
- Open-ended investment companies
- Exchange-traded funds (ETFs)
- Closed-ended investment
- Investment companies
3.1 Open-ended collective investment schemes
- no restrictions on the amount of shares (’units’) the fund issues
- the fund must by back shares when investors wish to sell
- the size of the fund is dictated by the amount of investment in it
- $ per share = Net Asset Value / # shares
- NAV = total value of assets at current market value - any liabilities
3.2 Unit trusts
- Sold in units not shares
- If the unit holder wish to sell the units
- Fund re-sells the units to others to repay. Since there is no secondary market, investors do not trade with each other but trade through a financial adviser, discount broker or fund supermarket.
- Fund sells assets held to repay
- $ unit = market valuation of the securities owned / # units
There are some charges of unit trusts:
- Initial charge (’sales’ or ‘front-end’ charge):
- Annual charges
- Exit charges
3.3 Open-ended investment companies (OEICs)
An OEIC is a company which can be listed on the stock exchange and it issues shares, it is more flexible and simpler than unit trusts.
- One price for both buyers and sellers
- Charges and dealing commissions are shown separately, more transparent
3.4 Exchange-traded funds (ETFs)
ETFs are set up as companies issuing shares and the money raised is used to buy a range of securities to track a stock market index.
ETFs are quoted companies
- Share prices are not set in the same way as OEICs or unit trusts
- Share prices are affected by trading in the market
Two types ETFs: traditional ETFs and synthetic ETFs
Traditional ETF
Suppose an ETF tracking FTSE 100 and initially has $100m to invest. Since in FTSE 100, BP comprises 8% and Whitbread comprises 0.15%, thus
- The ETF will invest in $8m worth shares of BP and $0.15m in Whitbread
- Synthetic ETF will not necessarily buy the actual shares but invest in derivatives to gain exposure of the returns in the same scale
For the market maker, they trade the ETF shares in the secondary market. Even though the price of an ETF is set by trading in the stock market, they tend to trade at, or near to the underlying net asset value because of no arbitrage.
3.5 Closed-ended collective investment
Collective investment vehicles that do not create or redeem shares on a daily basis.
- Publicly traded and the value of their shares fluctuates according to trading
- Have a fixed number of shares for lengthy periods
- Actively managed and often concentrate on a particular sector or industry (cannot deviate)
3.6 ESG and institutional investors
ESG investing represents a growing portion of overall capital market investments.
- Environmental
- Social
- Governance
Loading Comments...