COMMENTAR Y
INVESTMENT RISK
Market risk Survey responses suggested the 2008 financial crisis and subsequent recession not only increased institutional investors’ desire to implement risk management practices, but directly influenced their priorities and the kinds of risk management practices implemented. For example, the low-yield environment, extreme market shifts, financial market contagion and liquidity responses were
Fig.2 Rating investment policy risk measures 0 = Not important at all 3 = Neutral 5 = Extremely important
Underachieving your overall return targets Underperforming against liabilities Underachieving your benchmark Reduction in the level of plan contributions VaR limits
Underperforming relative to your peer group Exceeding tracking error targets
4.5
4.25 4.0 3.5 3.0 2.9
2.75 012345
rated as the most important market risks facing institutional investors in the 2013 Risk Survey. In fact, 100% of pension funds rated “the interest rate and current yield environment” to be either an important or extremely important market risk. The market risk categories whose importance increased most since the 2005 survey were “derivatives volatility, extreme market shifts, liquidity, financial market contagion and credit/ counterparty default risks,” all emblematic of the 2008 financial crisis (see Fig.1, previous page).
Source: BNY Mellon
Investment risk measures In a significant shift since our 2005 survey, respondents to the 2013 survey rated “under-achieving overall return targets” and “underperforming versus liabilities” as their two most important risk policy measures (see Fig.2). Between the 2005 and 2013 risk surveys, these two measures increased more than any other response within this section. If one considers liabilities as a form of performance target, the general shift in the focus of risk management from relative-to- benchmark to relative-to-target outcome becomes even more apparent. The “reduction in the level of plan contributions, VAR, and exceeding tracking error targets” all support the importance of achieving objectives relative to targets. Drilling into the detail, we can see that 100% of public pension funds and 100% of endowments/foundations said “underachieving overall return targets” was “important or extremely important”; 84% of corporate pension funds indicated the same (see Fig.3). None of the endowments/foundations, public pensions or corporate pensions indicated underachieving return targets was unimportant. In some cases, achieving return targets also implies avoiding downside risk.
Fig.3 Rating the importance of not achieving your return targets Important or extremely important
Public pension fund Corporate pension fund Endowment and foundation
75% Neutral Not very important or not important at all 100% 84% 100% 80% 85% 90% 95% 100% 16% Fig.4 Rating the importance of underperforming against liabilities Extremely important
Public pension fund Corporate pension fund
0% 20% Important Neutral 53% 69% 40% 60% Not important at all 28% 25% 80% 14% 6% 100% 3% Source: BNY Mellon
In 2005, “underachieving your benchmark” was the most important market measure. Also, relative to the 2005 survey, “underachieving your benchmark” and “exceeding tracking error targets” dropped in importance more than any other response in this section. In contrast, only 50% of public pension funds and 39% of corporate pension funds said that “underachieving your benchmark” was “extremely important.” This represents an important finding because it shows a shift in approach away from chasing alpha and toward achieving specific targets since 2005.
OPERATIONAL RISK
Operational risk has taken on new-found significance in light of the spectacular failures in the financial industry during the 2008 financial crisis. Although operational risk is not a new field, arriving at its
48 Source: BNY Mellon
Performance versus liabilities Looking more closely at performance versus liabilities responses, we can see that 94% and 82% of corporate pensions and public pensions also indicated underperforming against liabilities was either extremely important or important (see Fig.4). The lower response from public plans relative to corporate plans is consistent with the differentiating characteristics of each investor type, in particular, accounting and regulatory differences and the differing sources of sponsor capital that, at the margin, encourage a different risk management perspective.
Page 1 |
Page 2 |
Page 3 |
Page 4 |
Page 5 |
Page 6 |
Page 7 |
Page 8 |
Page 9 |
Page 10 |
Page 11 |
Page 12 |
Page 13 |
Page 14 |
Page 15 |
Page 16 |
Page 17 |
Page 18 |
Page 19 |
Page 20 |
Page 21 |
Page 22 |
Page 23 |
Page 24 |
Page 25 |
Page 26 |
Page 27 |
Page 28 |
Page 29 |
Page 30 |
Page 31 |
Page 32 |
Page 33 |
Page 34 |
Page 35 |
Page 36 |
Page 37 |
Page 38 |
Page 39 |
Page 40 |
Page 41 |
Page 42 |
Page 43 |
Page 44 |
Page 45 |
Page 46 |
Page 47 |
Page 48 |
Page 49 |
Page 50 |
Page 51 |
Page 52 |
Page 53 |
Page 54 |
Page 55 |
Page 56 |
Page 57 |
Page 58 |
Page 59 |
Page 60 |
Page 61 |
Page 62 |
Page 63 |
Page 64 |
Page 65 |
Page 66 |
Page 67 |
Page 68 |
Page 69 |
Page 70 |
Page 71 |
Page 72