Risk management is top of mind for pension plan sponsors in the wake of 2008—and it will be even more important moving forward, according to a 2014 BNY Mellon survey of more than 100 institutional investors. A panel discussion at the 2014 Risk Management Conference, held in Muskoka, Ontario from August 13-15, highlighted the results of the survey, as well as plan sponsors’ reactions to them. The panel was comprised of Catherine Thrasher, managing director of BNY Mellon, and Asif Haque, director, investments, with the CAAT Pension Plan, and was moderated by Caroline Cakebread, editor of Canadian Investment Review. Panel members focused on five key findings from the survey results:
1. growth in importance of risk management;
2. increased concerns about unintended bets;
3. greater focus on achieving targeted returns over alpha;
4. increased use of alternatives for diversification;
5. use of quantitative computer-based models to evaluate risk.
Risks and Benefits
Institutional investors see risk management as a key concern, with the majority expecting to allocate more time to it and 59% saying it has benefited their organization. Haque agreed that risk management is a priority for CAAT. “We feel that we have worked to advance our own risk management processes over the last five years—not only on the investment side, but in all facets of the organization—and that work has brought benefits to us.”
However, where institutional investors are focusing their energies is changing. The survey results show that investors expect to spend more time on investment and operational risks and less on political risk (with the exception of EMEA respondents). “Interestingly, not one respondent said they would spend less time on investment risk or operational risk,” Thrasher added.
The market events of 2008 and the following recession were the greatest influences on this new risk focus, according to 68% of respondents, followed by increased management awareness and knowledge (63%).
“The events of 2008 were the awakening; it was the wake-up call that maybe we didn’t know as much about our portfolios as we thought,” Thrasher explained, adding that investors today are demanding more information. While Haque believes CAAT’s practices would have evolved in this direction anyway, he conceded, “I think it’s fair to say that all of us were hit hard in 2008, and that certainly did spur more specific actions on our side.”
Reacting to the survey results during the question period, delegate John Poos, vice-president, pension & benefits, with Weston/Loblaws, agreed. “It provided a vehicle to describe to management what we’re doing, why we’re doing it and why it mattered.”
When it comes to market risks, critical concerns for institutional investors are interest rate risk, the low-yield environment, extreme market shifts and financial market contagion. “It’s a very, very difficult environment for plan sponsors,” Thrasher acknowledged. “And we’ve seen that in the amount of discussion around LDI.”
Looking specifically at investment risk, unmanaged and unintended bets are a leading concern, followed by unintended leverage. “There are risks that we all need to take in order to do our jobs properly … you obviously don’t want risks in the portfolio that you didn’t know about or couldn’t quantify with any accuracy,” said Haque, adding that, with the backdrop of 2008, CAAT has improved scenario analysis and is asking better questions regarding its portfolio.
While it’s not as broadly discussed, liquidity is another risk that can have a significant impact, Haque added, referring to the margin calls in 2008. “All of this cash had to come from somewhere. Those were trying times just from a pure liquidity perspective, and we’ve evolved our liquidity management—our cash management processes, the way we run those overlay programs—significantly in response to that.”
To combat some of these risks, the panel explained, institutional investors are turning to strategies such as LDI, and are increasingly looking at alternatives such as commodities, hedge funds, private equities and real estate, for diversification purposes.