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Pension Funds Make a Formal Study of Risk

Plan sponsors are hiring software houses that specialize in portfolio analytics to prepare plan-wide reports.

Risk and reward may be the yin and yang of investing, but plan sponsors are increasingly turning their attention to the risk part of that duo. They are creating formal systems for managing risk, demanding better analytical tools, perhaps changing their asset allocation, and in some cases hiring dedicated risk officials.

“What undoubtedly led to it was the complexity of the investment strategies we all had. It has become more challenging to manage all these elements,” explains Jane Western, whose title says it all: managing director for risk management and trust operations at Boeing Company’s $80 billion defined benefit and defined contribution plans.

Boeing was a pioneer. Back in late 2005, six members of the investment staff “intensively spent” about nine months developing a risk management gap analysis, according to Western. Starting with a now-classic 1996 paper from a group of 11 plan sponsors that spelled out 20 categories of investment risk, the Boeing staff “identified about 100 different risk actions that we thought were appropriate in trying to fulfill those risk categories,” Western says. Then, with help from the plan’s custodians and consultant, “we tried to rate ourselves, to identify areas where we felt we wanted to provide additional focus.”

For other large plans, the impetus was the financial crisis and the shock of realizing “they were concentrated in certain strategies or even names,” says Karyn Williams, a managing director at Wilshire Associates who specializes in risk. Now, “the desire is to have a system that tells them where they are exposed across the market.”  While an individual asset management firm may be able to answer questions about its own strategy, benchmarks, and risk exposure, Williams says, there is no coordination. “Each manager would have their own way of measuring and reporting. It’s as if you’re speaking 10 different languages.”

Thus, plan sponsors are hiring firms like Wilshire, MSCI, and software houses that specialize in portfolio analytics to prepare a plan-wide report. Williams says that in the past two years Wilshire has been getting five to 10 requests annually from pension funds, up from just one or two per year.

Meanwhile, Boeing and about a dozen other large plans have formed a task force to ask vendors to provide quantitative, total-fund analysis “easily and on a clean basis, monthly, in a manner we could understand,” as Western puts it. The task force members confer every other week, mainly by phone.

Although Boeing hasn’t changed its asset allocation, Williams says that is one likely result of this kind of analysis. For instance, a pension fund might index some equities to compensate for an unexpected level of risk elsewhere in the portfolio.

This approach also spurs more teamwork, because the portfolio must be looked at in its entirety, Williams says. A handful of plans have even hired people specifically dedicated to risk management as at least part of their duties.

If this systematic approach to risk had been in place during the financial crisis, would plans have cut their losses?

“They might have decided, ‘If we’re down 20 percent, we need to pull back from active risk or put some kind of hedging program in place,’ ” Williams says. But other plan sponsors might have stuck with their asset allocation, keeping their focus on their long-term strategy.

What matters, she adds, is that “they would have known where they’re highly concentrated and exposed in places they didn’t intend. They would be aware of the risks.”

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