CFA Examination Level III
Giselle Donovan is the newly appointed Chief Financial Officer of Bontemps International (BI), an import/export firm conducting a worldwide trading business from its principal office in New York. BI is a financially healthy, rapidly growing firm with a young workforce. All liabilities are denominated in U.S. dollars. Its ERISA-qualified defined-benefit pension plan is structured as follows: .
|Higher-Risk Asset Classes|
|U.S. equities (large capitalization)||35%||10.00%|
|U.S. equities (small capitalization)||10||12|
|Lower-Risk Asset Classes|
|U.S. Treasury bills (1-year duration)||10%||4.5|
|U.S. intermediates and mortgage-backed securities (4-year duration)||39||1|
|U.S. long-term bonds (10-year duration)||1||19.0*|
|Total fixed income||50%|
|Present value of plan liabilities||$298 million|
|Market value of plan assets||$300 million|
|Surplus||$ 2 million|
|Duration of liabilities||10 years|
|Actuarial return assumption||7.00%|
|BI Boardâ€™s long-term total return objective||9.00%|
The Board is concerned about the pension portfolioâ€™s downside risk and wants to adopt a formal policy for rebalancing the planâ€™s assets in response to fluctuations in market values. Donovan asks you to review the major strategies that the Board should consider. You are aware of three strategies used to reallocate between higher-risk and lower-risk assets: â€œConstant Mix,â€ â€œConstant Proportion,â€ and â€œBuy and Hold.â€
a. Describe the primary characteristics of each of these three strategies as they relate to changes in market values. Identify the market environment in which each strategy should provide the best relative performance.
b. Recommend one strategy for the Boardâ€™s consideration, taking their concerns into account. Justify your choice.