Portfolio Management for Institutional Investors (2024)

Refresher Reading

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2024 Curriculum CFA Program Level III Portfolio Management and Wealth Planning

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Institutional investors are corporations, trusts, or other legal entities that invest in financial markets on behalf of groups or individuals, including both current and future generations. On a global basis, institutional investors represent more than US$70 trillion in investable assets, and, as such, wield significant influence over capital markets.

The universe of institutional investors includes, but is not limited to, defined benefit and defined contribution pension plans, sovereign wealth funds, endowments, foundations, banks, and insurance companies. Pension plans, which account for approximately US$35 trillion in investable assets or roughly half of global institutional assets under management, include both defined benefit plans, in which the sponsor (employer) assumes investment risk, and defined contribution plans, in which the individual makes investment decisions and assumes the investment risk. Sovereign wealth funds, which account for about US$7 trillion in assets as of the end of 2016, are government-owned investment funds that invest in financial and/or real assets. Endowments and foundations, which account for approximately US$1.6 trillion in assets, manage assets on behalf of educational institutions, hospitals, churches, museums, and other charitable organizations. Banks and insurance companies, comprising net financial assets on the order of US$9 trillion, are financial intermediaries that balance portfolios of securities, loans, and derivatives for the purposes of (i) meeting the claims of depositors, counterparties, policyholders, and creditors and (ii) providing adequate returns to their contractual capital holders. The universe of institutional investors is comprised of large, complex, and sophisticated investors that must contend with a multitude of investment challenges and constraints.

There has been an important shift in the asset allocation of institutional investors over the last half century. In the 1970s, most pensions and endowments invested almost exclusively in domestic, fixed-income instruments. In the 1980s, many institutional investors began to invest in equity markets and often pursued a long-term strategic allocation of 60% equities/40% fixed income. In the 1990s, investors recognized the benefits of diversification and many made their first forays into international equity markets. At the turn of the 21st century, many of the world’s largest pension funds and endowments further diversified their portfolios and increased investments in alternative asset classes, including private equity, hedge funds, real estate, and other alternative or illiquid assets.

Meanwhile, institutional investors have seen broad shifts in their strategic investment behavior. The trend toward Liability Driven Investing (LDI), long a mainstay of banks and insurance companies, has taken hold among many defined benefit pension plans, particularly US corporate and public pension funds. Sovereign wealth funds have amassed significant assets over the past several decades, and many have implemented innovative investment approaches characterized by active management. Many endowments have adopted the “Endowment Model” of investing that involves significant exposure to alternative investments. Meanwhile, banks and insurers must navigate a complex and ever-changing economic and regulatory environment.

In this reading, we endeavor to put the numerous factors that affect investment by institutional investors into context. Section 2 discusses common characteristics of institutional investors as a group. Section 3 provides an overview of investment policies for institutional investors. Detailed coverage by institutional investor type begins with Section 4, pension funds, where we discuss various factors that influence investments, including: stakeholders, liability streams, investment horizons, and liquidity needs; major legal, regulatory, accounting, and tax constraints; investment objectives and key components of Investment Policy Statements; and, finally, asset allocation and investment portfolios that emanate from the foregoing factors and constraints. Section 5 follows the same approach for sovereign wealth funds, and Section 6 does the same for university endowments and private foundations. Section 7 covers banks and insurers and includes balance sheet management considerations. A summary of key points concludes the reading.

Learning Outcomes

The member should be able to:

  1. discuss common characteristics of institutional investors as a group;

  2. discuss investment policy of institutional investors;

  3. discuss the stakeholders in the portfolio, the liabilities, the investment time horizons, and the liquidity needs of different types of institutional investors;

  4. describe the focus of legal, regulatory, and tax constraints affecting different types of institutional investors;

  5. evaluate risk considerations of private defined benefit (DB) pension plans in relation to 1) plan funded status, 2) sponsor financial strength, 3) interactions between the sponsor’s business and the fund’s investments, 4) plan design, and 5) workforce characteristics;

  6. prepare the investment objectives section of an institutional investor’s investment policy statement;

  7. evaluate the investment policy statement of an institutional investor;

  8. evaluate the investment portfolio of a private DB plan, sovereign wealth fund, university endowment, and private foundation;

  9. describe considerations affecting the balance sheet management of banks and insurers.


This reading has introduced the subject of managing institutional investor portfolios. The key points made in this reading are as follows:

  • The main institutional investor types are pension plans, sovereign wealth funds, endowments, foundations, banks, and insurance companies. Common characteristics among these investors include a large scale (i.e., asset size), a long-term investment horizon, regulatory constraints, a clearly defined governance framework, and principal–agent issues.

  • Institutional investors typically codify their mission, investment objectives, and guidelines in an Investment Policy Statement (IPS).

  • Four common investment approaches to managing portfolios used by institutional investors are the Norway model, the Endowment model, the Canada model, and the Liability Driven Investing (LDI) model.

  • There are two main types of pension plans: defined benefit (DB), in which a plan sponsor commits to paying a specified retirement benefit; and defined contribution (DC), in which contributions are defined but the ultimate retirement benefit is not specified or guaranteed by the plan sponsor.

  • Pension plan stakeholders include the employer, employees, retirees, unions, management, the investment committee and/or board of directors, and shareholders.

  • The key elements in the calculation of DB plan liabilities are as follows:

    • Service/tenure: The higher the service years, the higher the retirement benefit.

    • Salary/earnings: The higher the salary over the measurement period, the higher the retirement benefit.

    • Mortality/longevity: The longer the participant’s expected life span, the higher the plan sponsor’s liability.

    • Vesting: Lower turnover results in higher vesting, increasing the plan sponsor’s liabilities.

    • Discount rate: A higher discount rate reduces the present value of the plan sponsor’s liabilities.

  • DB plan liquidity needs are driven by the following:

    • Proportion of active employees relative to retirees: More mature pension funds have higher liquidity needs.

    • Age of workforce: Liquidity needs rise as the age of the workforce increases.

    • Plan funded status: If the plan is well funded, the sponsor may reduce contributions, generating a need to hold higher balances of liquid assets to pay benefits.

    • Flexibility: Ability of participants to switch among the sponsor’s plans or to withdraw from the plan.

  • Pension plans are subject to significant and evolving regulatory constraints designed to ensure the integrity, adequacy, and sustainability of the pension system. Some incentives, such as tax exemption, are only granted to plans that meet these regulatory requirements. Notable differences in legal, regulatory, and tax considerations can lead to differences in plan design from one country to another or from one group to another (e.g., public plans vs. corporate plans).

  • The following risk considerations affect the way DB plans are managed:

    • Plan funded status

    • Sponsor financial strength

    • Interactions between the sponsor’s business and the fund’s investments

    • Plan design

    • Workforce characteristics

  • An examination of pension fund asset allocations shows very large differences in average asset allocations by country and within a country despite these plans seeking to achieve similar goals. Such inter- and intra-national differences are driven by many factors, including the differences in legal, regulatory, accounting, and tax constraints; the investment objectives, risk appetites, and investment views of the stakeholders; the liabilities to and demographics of the ultimate beneficiaries; the availability of suitable investment opportunities; and the expected cost of living in retirement.

  • The major types of sovereign wealth funds (SWFs) follow:

    • Budget Stabilization funds: Set up to insulate the budget and economy from commodity price volatility and external shocks.

    • Development funds: Established to allocate resources to priority socioeconomic projects, usually infrastructure.

    • Savings funds: Intended to share wealth across generations by transforming non-renewable assets into diversified financial assets.

    • Reserve funds: Intended to reduce the negative carry costs of holding foreign currency reserves or to earn higher return on ample reserves.

    • Pension Reserve funds: Set up to meet identified future outflows with respect to pension-related, contingent-type liabilities on governments’ balance sheets.

  • Stakeholders of SWFs include the country’s citizens, the government, external asset managers, and the SWF’s management, investment committee and board of directors.

  • Given their mission of intergenerational wealth transfer, SWFs do not generally have clearly defined liabilities, so do not typically pursue asset/liability matching strategies used by other institutional investor types.

  • Sovereign wealth funds have differing liquidity needs. Budget stabilization funds require the most liquidity, followed by reserve funds. At the other end of the spectrum are savings funds with low liquidity needs, followed by pension reserve funds.

  • The investment objectives of SWFs are often clearly articulated in the legislative instruments that create them. They are often tax free in their home country, though must take foreign taxation into consideration. Given their significant asset sizes and the nature of their stakeholders, SWFs have aimed to increase transparency regarding their investment activities. In this regard, the Santiago Principles are a form of self-regulation.

  • The typical asset allocation by SWF type shows budget stabilization funds are invested mainly in bonds and cash given their liquidity needs. Reserve Funds invest in equities and alternatives but maintain a significant allocation of bonds for liquidity. Savings funds and pension reserve funds hold relatively higher allocations of equities and alternatives because of their longer-term liabilities.

  • Endowments and foundations typically invest to maintain purchasing power while financing their supporting university (endowments) or making grants (foundations) in perpetuity—based on the notion of intergenerational equity. Endowments and foundations usually have a formal spending policy that determines how much is paid out annually to support their mission. This future stream of payouts represents their liabilities. For endowments, other liability-related factors to be considered when setting investment policy are: 1) the ability to raise additional funds from donors/alumni, 2) the percentage of the university’s operating budget provided by the endowment, and 3) the ability to issue debt.

  • Foundations and endowments typically enjoy tax-exempt status and face relatively little regulation compared to other types of institutional investors.

  • Foundations face less flexible spending rules compared to endowments; foundations in the US are legally mandated to pay out 5% of their assets annually to maintain tax-exempt status. Endowments and foundations have relatively low liquidity needs. However, foundations have somewhat higher liquidity needs (vs. endowments), because they 1) typically pay out slightly more as a percentage of assets, and 2) finance the entire operating budget of the organization they support.

  • Endowments and foundations typically have a long-term real return objective of about 5% consistent with their spending policies. This real return objective, and a desire to maintain purchasing power, results in endowments and foundations making significant allocations to real assets. In general, endowments and foundations invest heavily in private asset classes and hedge funds and have relatively small allocations to fixed income.

  • Banking and insurance companies manage both portfolio assets and institutional liabilities to achieve an extremely high probability that obligations on deposits, guarantees, derivatives, policyholder claims, and other liabilities will be paid in full and on time.

  • Banking and insurance companies have perpetual time horizons. Strategically, their goal is to maximize net present value to capital holders; tactically, this may be achieved by liability driven investing (LDI) over intermediate and shorter horizons.

  • Financial institutions are highly regulated because of their importance to the non-financial, or real, sectors of the economy. Such institutions are also regulated in order to minimize contagion risk rippling throughout the financial and real sectors.

  • The underlying premise of regulation is that an institution’s capital must be adequate to absorb shocks to both asset and liability values. This implies limiting the volatility of value of the institution’s shareholder capital.

  • The volatility of shareholder capital can be managed by (a) reducing the price volatility of portfolio investments, loans, and derivatives; (b) lowering the volatility from unexpected shocks to claims, deposits, guarantees, and other liabilities; (c) limiting leverage; and (d) attempting to achieve positive correlation between changes in the value of assets and liabilities.

  • Ample liquidity, diversification of portfolio and other assets, high investment quality, transparency, stable funding, duration management, diversification of insurance underwriting risks, and monetary limits on guarantees, funding commitments, and insurance claims are some of the ways management and regulators attempt to achieve low volatility of shareholder capital value.


Members' Guide to 2023 Refresher Readings (PDF)

Performance Attribution

Investment Manager Selection

Performance Evaluation: Return Measurement and Data Integrity


Manage your Professional Learning credits


Multi-Asset Strategies

Equity Investments

Pension Fund Governance

Financial Regulation

Alternative Assets

Sovereign Wealth Funds

Investment Funds

Fixed Income Investments

Hedge Funds


Financial Markets

Investment Management Strategies

Fundamental Analysis

Economic Conditions

Capital Structure

Private Wealth Management


Active Management


Trading Strategies


Client Relationships

As a financial expert with a demonstrated understanding of institutional investors and their portfolio management, I can provide valuable insights into the concepts covered in the provided article.

Institutional Investors: Institutional investors are corporations, trusts, or legal entities that invest in financial markets on behalf of groups or individuals. They represent over $70 trillion in investable assets globally and include pension plans, sovereign wealth funds, endowments, foundations, banks, and insurance companies.

Asset Allocation Trends: There has been a significant shift in institutional investors' asset allocation over the last few decades. In the 1970s, most invested in domestic fixed-income instruments. In subsequent decades, they diversified into equity markets, international equities, and alternative assets like private equity, hedge funds, real estate, and other illiquid assets.

Liability Driven Investing (LDI): The trend toward LDI, commonly practiced by banks and insurance companies, has gained traction among defined benefit pension plans, especially in the US. LDI involves aligning investments with liabilities to better manage risk.

Pension Plans: Defined Benefit (DB) and Defined Contribution (DC) pension plans are major types. Stakeholders include employers, employees, retirees, unions, and management. Factors influencing investments include service/tenure, salary/earnings, mortality/longevity, vesting, and discount rate. Liquidity needs are driven by factors like the age of the workforce and plan funded status.

Regulatory Constraints: Pension plans face significant regulatory constraints to ensure system integrity, adequacy, and sustainability. Legal, regulatory, and tax considerations vary, leading to differences in plan design among countries and groups.

Sovereign Wealth Funds (SWFs): SWFs, with about $7 trillion in assets, include various types like budget stabilization funds, development funds, savings funds, reserve funds, and pension reserve funds. Stakeholders include citizens, government, external asset managers, and SWF management. SWFs have diverse liquidity needs based on their specific types.

Endowments and Foundations: These entities invest to maintain purchasing power and support their mission perpetually. They face relatively low regulation and enjoy tax-exempt status. Endowments and foundations typically have long-term real return objectives and allocate significantly to real assets.

Banking and Insurance Companies: These institutions manage both portfolio assets and liabilities. Their perpetual time horizons aim to maximize net present value. Regulation is stringent to minimize contagion risk, and strategies involve managing volatility through diversification, duration management, and limiting leverage.

Risk Considerations: Risk considerations for institutional investors include plan funded status, sponsor financial strength, interactions between sponsor business and fund investments, plan design, and workforce characteristics.

Regulation and Risk Management: Regulation for financial institutions emphasizes maintaining adequate capital to absorb shocks, limiting volatility in shareholder capital, managing liquidity, diversifying portfolio assets, and ensuring transparency.

In conclusion, this refresher reading provides a comprehensive overview of institutional investors, their investment approaches, regulatory constraints, and risk considerations across various types of entities in the financial landscape. It is a valuable resource for anyone seeking a deeper understanding of portfolio management for institutional investors.

Portfolio Management for Institutional Investors (2024)
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