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© Copyright 2000 Rogers Media. The following article first appeared in the April 2000 edition of
BENEFITS CANADA magazine.
Protecting against risk
Risk management is more important than ever
By Barry McInerney
Risk management has never been more relevant than now. Despite pension plans in Canada enjoying
unprecedented double-digit returns during most of the 1990s, the risk tolerance level of many pension plans
is diminishing as their plan membership matures.
Let's begin our risk management journey with the Canadian stock market. The Toronto Stock Exchange (TSE)
300 composite index is in jeopardy of becoming an increasingly marginal index. With the surge in the share
prices of Nortel Networks and BCE Inc., and given BCE's proposed spin-off of its stake in Nortel by
mid-year, Nortel will comprise a staggering 30% of the TSE 300.
The market capitalization of the Canadian stock market--roughly 2% of the world--is similar to that of
Italy, the Netherlands and Switzerland. We must not compare ourselves to U.S. stock markets, which are
generally large and highly diversified.
How do we protect ourselves against possible downside volatility associated with a concentrated market?
Plan sponsors should consider capping exposure at a percentage of the fund and adjusting the benchmark for
investment managers consistent with prudent risk diversification principles. However, the long-term
solution for investors is to simply reduce the role of domestic equities in the overall portfolio, thereby
reducing reliance on those few dominant domestic stocks.
If increased foreign equity exposure seems so apparent, what is the appropriate non-domestic policy level?
Our research indicates that a foreign equity allocation of one-half to two-thirds of the overall equity
portfolio seems appropriate. The recently announced increase to the foreign property limit will better
equip plan sponsors.
Continuing with our theme of risk management, what about active vs. passive management? The majority of the
literature on this topic comprises an ongoing debate on the merits of one or the other as the preferred
investment strategy. Should we not now look beyond the tired arguments of active vs. passive and, instead,
devote our attention to the more productive exercise of defining the proportionate role of both within a
portfolio? Let's end the debate and instead view passive management as an additional risk management tool
available to Canadian investors.
Finally, the principle behind hiring managers with offsetting styles may have broken down. For example,
1999 was a strong year in the equity markets, yet many managers--growth and value--underperformed.
Instead of, or in addition to, the conventional growth/value style offset model, a more useful way to
manage risk might be to construct a market-like vs. non-market-like manager offset. That way, one manager
can always be expected to be close to the market, even if market valuations and opportunities do not fit
with conventional thoughts of good value or good long-term investing.
There are many other issues and trends that will impact investment decisions over the coming years. A
common thread among these key investment decisions is risk management. Basing decisions about the financial
health of the retirement system on sound, risk diversification principles will always be the high road for
pension fiduciaries.
Barry McInerney is the national investment consulting practice leader for William M. Mercer Limited in
Toronto.
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