Investment and Asset Management
Domain focus
SP5 tests how an actuary designs, monitors and explains an investment strategy that meets liability and capital objectives. Expect questions on asset-liability modelling, portfolio construction, risk measurement, derivatives overlays, performance attribution and governance. Answers need explicit links between assets, liabilities, constraints and the client’s risk appetite, not just product knowledge.
Core rules and concepts
- Start from the liability profile: timing, currency, inflation linkage and liquidity determine the strategic benchmark.
- Mean–variance optimisation is an input, not an answer; constraints, transaction costs, tax and governance can dominate.
- Measure interest-rate exposure with DV01 or modified duration, and check convexity where cash flows are long-dated.
- Derivatives can adjust duration, currency or equity exposure without trading the physical portfolio; collateral, basis and counterparty risk remain.
- Performance should be decomposed into policy, benchmark and active effects; use appropriate risk-adjusted measures such as information ratio for active mandates.
- Alternative assets require valuation, liquidity and fee analysis; reported volatility may understate risk.
Worked example
A scheme has assets of £600m with modified duration 8 and liabilities of £500m with modified duration 12. Asset DV01 is £600m × 8 × 0.0001 = £480k. Liability DV01 is £500m × 12 × 0.0001 = £600k. The net DV01 is therefore £120k: rates falling by one basis point improve the surplus by about £120k, so the scheme is exposed to rising rates. A receive-fixed swap with duration 5 has DV01 per £100m of notional of £100m × 5 × 0.0001 = £50k. To neutralise the gap, notional = £120k ÷ £50k × £100m = £240m. The reasoning must state direction, duration and DV01; a notional alone is not a hedge.
Traps
Do not confuse Macaulay and modified duration, or compare nominal asset and liability exposures without DV01. Ignore convexity at your peril. Derivative overlays are levered and collateral-hungry, so a perfect duration hedge can fail on cash or counterparty terms. In performance questions, distinguish return measurement from attribution and check benchmark appropriateness. For illiquid assets, challenge smooth valuations and fee drag.