PA 546 Constantine Hadjilambrinos Fund Management Lecture 14 December 6, 2005
PA 546 Constantine Hadjilambrinos Cash Management • Accelerate collections. • Control disbursements. • Consolidate balances. • Invest idle funds.
PA 546 Constantine Hadjilambrinos Cash investment strategy: • Forecast cash flows. • 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.
PA 546 Constantine Hadjilambrinos Public Employee Retirement Funds • State and local government employee retirement funds > $ 2.5 trillion
PA 546 Constantine Hadjilambrinos Public Employee Retirement Fund Management 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). • 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. • This capital must be invested so as to be able to produce the funds needed when the employee retires.
PA 546 Constantine Hadjilambrinos Employer has two options for funding defined benefit plans: • Pay-as-you-go—current contributions fund current benefits. • Actuarial funding—current contributions fund future benefits.
PA 546 Constantine Hadjilambrinos Actuarial funding requires effective management: • Fund manager must estimate accurately employees’ lifespan. • 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. • Investment risk is born by employer.
PA 546 Constantine Hadjilambrinos Appropriate Investments • Long-term investments—high return potential. • Short-term investments—necessary to actually pay benefits. • Creditworthiness. • Liquidity. • Market rate of return.
PA 546 Constantine Hadjilambrinos Defined contribution plans • Employee contributes amounts (often matched by employer) to a fund managed by employee. • Most private and public employers offer this option. • The only option offered by most private employers. • Higher portability than defined benefit plans. • Investment risk borne by employee.
PA 546 Constantine Hadjilambrinos Infringements on pension fund management: • 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. • Unwise restrictions of investment—to local firms, social investing, economically targeted investing. • Size of pension funds can impact private sector.
PA 546 Constantine Hadjilambrinos Effects of differential growth rates Year 0 Year 5 Year 7