A Brief Overview of CFA L3's Institutional IPS Material

CFA level three study session four on the institutional investment policy statement is a pivotal section that builds directly on managing the individual IPS (which we've covered extensively here).

One of the main differences in looking at the institutional vs. individual context is that we're now shifting from that interplay of behavioral finance with traditional finance and really concentrating on investors that we assume to be fully rational. 

The Institutional IPS is a Major Standalone L3 Exam Question

Just like the individual IPS material, the institutional problem is going to be worth 20+ points.

For the most part the format is the same too.  It’s still RR-TTLLU: risk tolerance/return objectives and calculation, and the five constraints

The main difference is that the institutional investor material has more compare and contrast style questions probing your knowledge of the differences between different types of institutional investors.

On the CFA L3 exam for example you might be asked to talk about the difference between two different defined benefit pension plans based on the underlying workforce characteristics or financial strength of the respective companies. On a foundation/endowment style question it might ask you to pick out risk tolerance based on how dependent the supported organization is on ongoing donations. From an insurance company perspective, you'll need to talk about life insurance vs. P&C insurers based on the predictability (timing and amount) of liabilities. 

Types of Institutional IPS Exam Questions

Outside of having a clear understanding of the constraints and the risk and return objectives of each institution type, there are a couple of other common ways the level three exam could test you. 

The first relates to the idea of managing one's assets against liabilities. So that's asset liability management or ALM which we've seen extensively on L2. On the exam, you could see a compare/contrast question in which you need to discuss two different institution’s risk tolerance based on the degree of obligation towards liabilities (i.e. a bank’s deposit obligations vs. a foundation’s desire to fund an organization). The flip side of ALM is an asset only (AO) approach.

Second, you should expect a problem on spending rules. In this case that relates primarily to foundations and endowments, where the spending rule essentially is part of the calculation of their return objective.

The constraints are also tested in ways that differ slightly from the individual context. First, liquidity tends to be more of a calculation heavy question (don't forget to include management fees!). You should also be on the lookout for inappropriate investments, based either on liquidity needs, lack of expertise in evaluating alternative assets, or an asset-liability mismatch.

Summarizing L3's Testable Material

Institutional IPS CFA L3 Overview 

Now I'm not going to lie. This section is a bit boring but it is vital and there's a lot of detail here. Luckily, each individual piece of information is not overly complicated. You just need to drill old morning mock exam examples so you don't get caught by surprise (see 6 common errors L3 candidates make).