Fund Management Lecture 14 December 6, 2005 PA 546 Constantine Hadjilambrinos

Cash Management PA 546 Constantine Hadjilambrinos Accelerate collections. Accelerate collections. Control disbursements. Control disbursements. Consolidate balances. Consolidate balances. Invest idle funds. Invest idle funds.

Cash investment strategy: PA 546 Constantine Hadjilambrinos Forecast cash flows. Forecast cash flows. Undertake prudent investments. Undertake prudent investments.  No default risk (no commercial securities).  No credit market risk (only short term securities).  No artificially low rates of return (no tax-free interest bonds).  No illiquid assets.  Observe special limits placed by federal, state, and local laws.

Public Employee Retirement Funds PA 546 Constantine Hadjilambrinos State and local government employee retirement funds > $ 2.5 trillion State and local government employee retirement funds > $ 2.5 trillion

Public Employee Retirement Fund Management PA 546 Constantine Hadjilambrinos Almost all public employee retirement plans include a defined benefit option. Defined benefit option pays employee a certain annual amount (based, in some way, on annual salary). Defined benefit option pays employee a certain annual amount (based, in some way, on annual salary). This amount stays the same for the retired employee’s lifetime and often increases with inflation. This amount stays the same for the retired employee’s lifetime and often increases with inflation. Employee contributes a fixed portion of his/her salary, most often matched by employer, to a retirement fund. Employee contributes a fixed portion of his/her salary, most often matched by employer, to a retirement fund. This capital must be invested so as to be able to produce the funds needed when the employee retires. This capital must be invested so as to be able to produce the funds needed when the employee retires.

Employer has two options for funding defined benefit plans: PA 546 Constantine Hadjilambrinos Pay-as-you-go—current contributions fund current benefits. Pay-as-you-go—current contributions fund current benefits. Actuarial funding—current contributions fund future benefits. Actuarial funding—current contributions fund future benefits.

Actuarial funding requires effective management: PA 546 Constantine Hadjilambrinos Fund manager must estimate accurately employees’ lifespan. Fund manager must estimate accurately employees’ lifespan. Adequate funds must be invested during employee’s working years. Adequate funds must be invested during employee’s working years. Funds must be invested in a way that will generate adequate returns to fund guaranteed benefits. Funds must be invested in a way that will generate adequate returns to fund guaranteed benefits. Investment risk is born by employer. Investment risk is born by employer.

Appropriate Investments PA 546 Constantine Hadjilambrinos Long-term investments—high return potential. Long-term investments—high return potential. Short-term investments—necessary to actually pay benefits. Short-term investments—necessary to actually pay benefits. Creditworthiness. Creditworthiness. Liquidity. Liquidity. Market rate of return. Market rate of return.

Defined contribution plans PA 546 Constantine Hadjilambrinos Employee contributes amounts (often matched by employer) to a fund managed by employee. Employee contributes amounts (often matched by employer) to a fund managed by employee. Most private and public employers offer this option. Most private and public employers offer this option. The only option offered by most private employers. The only option offered by most private employers. Higher portability than defined benefit plans. Higher portability than defined benefit plans. Investment risk borne by employee. Investment risk borne by employee.

Infringements on pension fund management: PA 546 Constantine Hadjilambrinos Use of pension funds by employer as market for its debt—or stock. Use of pension funds by employer as market for its debt—or stock. Political use of funds by government—loans, sale/lease-back of government assets, delayed contributions. Political use of funds by government—loans, sale/lease-back of government assets, delayed contributions. Unwise restrictions of investment—to local firms, social investing, economically targeted investing. Unwise restrictions of investment—to local firms, social investing, economically targeted investing. Size of pension funds can impact private sector. Size of pension funds can impact private sector.

Effects of differential growth rates Year 0Year 5Year 7 PA 546 Constantine Hadjilambrinos