Risk: Measuring Isn’t Managing

656316_tape-measureAs a speaker at this month’s Investment Innovation Conference in Arizona (November 30 – December 2), Dave Lawson, chief investment officer of Alberta’s Workers’ Compensation Board will be sharing his thoughts on how to ward off the kinds of risks pension plans unexpectedly encountered during the financial crisis. In advance of the conference, we asked him to answer questions on risk management and measurement and managing liquidity, among other things. To find out more about Dave’s presentation and the Investment Innovation Conference, click here.

Q: How did financial crisis affect pension plans?

A: I think the major impacts are fairly obvious in terms of asset values and funding levels – flowing through to contribution rates and the pain that comes with that. I think what it also did was open some eyes and raise some fresh thoughts on the risks that we take and the way we managed funds. There’s been a lot said and written and presented about what happened to the financial system and what happened to economies and what central banks are doing, but the point I wanted to raise is what specifically did we learn as pension fund managers and what can we do better going forward.

I think the important thing is what can we do better for tomorrow’s problems  – we’re always pretty good at managing yesterday’s problem.

Q: How do you focus on tomorrow’s problems?

A: The things I want to talk about are liquidity management – something that we and others had problems with. I want to talk about risk measurement systems and risk management, with some lessons from that and also about rebalancing asset mix and foreign exchange exposures.

Q: Let’s take a couple of these topics and look at what was learned.

A: Thinking liquidity, I think the key thing learned was that there was a belief that funds didn’t need liquidity, they had too much liquidity and could profit from selling liquidity. That’s all fine when things are running normally, but when we’re in a time of crisis, we need liquidity, first to manage day-to-day operations and second to be able take advantage of the opportunities that are presented. I think there were significant opportunities during and after the financial crisis and most didn’t have the ability to take advantage of them.

So then what we get into is how we are modelling our liquidity now, the probability of commitments to illiquid asset classes, margin calls and settlements on overlays and other liquidity needs, along with a framework for managing and monitoring it. What I’d like to tilt the presentation to is to share some practical ways you can do something rather than just point out things may be obvious already to many.

Q: How about risk management … I mean risk measurement? What are the lessons there?

A: Well that captures it right there – to reinforce that risk measurement is not  risk management but that measurement is only an input to the process. We learned that there were a lot of things that the model said had low correlations that in fact didn’t. That’s nothing new to people. I think where people make a mistake is in thinking that these risk systems can give you warnings when that’s not the case. It’s more like a speedometer, in that it tells you how fast you are going and how big a problem you might have if it goes wrong, but it can’t tell if or when it’s going to go wrong.

To learn more about the Investment Innovation Conference, visit the events section of the website. If you are interested in attending the event, please email Garth Thomas to be considered, as limited space is available.