A state pension covers 180,000 retired teachers. Its actuarial discount rate is 7.25%, but the portfolio earned 4.1% over the past decade. The funded ratio dropped from 92% to 68%. The board faces an impossible choice: raise contributions, cut benefits, or chase returns with more risk.
Before drilling into each investor type, note what they share. Institutional investors are pools of capital managed on behalf of beneficiaries who do not directly control the money. Whether the entity is a DB pension, a university endowment, a private foundation, a sovereign wealth fund, a bank, or an insurer, six characteristics recur:
- Scale. Asset bases run from hundreds of millions to several trillion dollars. Scale buys access to alternative managers, lower fees, internal staff, direct deals, and negotiating leverage that retail investors...
- Formal governance. A board or set of trustees sets policy. An investment committee approves the strategic asset allocation. A CIO and internal staff (or outsourced CIO) execute.
- Long horizons, with two exceptions. Pensions, endowments, foundations, sovereign wealth funds, and life insurers run on horizons of decades to perpetuity.
Common mistakes
- Recommending more risk for underfunded pensions to "close the gap." Underfunded plans have lower ability to take risk. Chasing returns compounds the problem if markets decline. The exam penalizes candidates who recommend aggressive allocations for underfunded plans without strong sponsor support.
- Forgetting the 5% minimum distribution for foundations. Unlike endowments, foundations cannot reduce distributions below 5% during bear markets. This makes the portfolio more vulnerable to sequence risk and requires higher liquidity.
- Treating all endowments as perpetual. Some endowments support limited-life programs. A foundation spending down over 20 years has fundamentally different risk characteristics than a perpetual endowment.
Bottom line
- DB pensions: funded status drives risk capacity, so underfunded plans have lower ability to take risk and should not chase returns.
- Endowment return target = spending rate + costs + inflation, so real return must exceed spending plus costs to preserve purchasing power.
- Foundations: the 5% minimum distribution is a binding floor that cannot be cut in bear markets, raising sequence risk and liquidity needs.
- Insurers: liability-driven, duration-matched, and regulatory-capital-constrained; life needs long duration, P&C needs shorter duration and more liquidity.
Exam shortcut
When the vignette describes a pension, identify funded status and workforce demographics immediately; they determine risk tolerance. When it describes an endowment, compute the real return target (spending + costs) and check whether the allocation can realistically achieve it. For foundations, the 5% floor is always the binding constraint; mention it even if the question does not ask. For insurers, the first question is always about duration matching.
The full lesson (about 3,974 words, 26 min read) adds 3 worked examples, all 8 common mistakes, a self-check, free in the app.
Learning objectives
- institutional investors
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