Page:      1   2

Nearly every feasible investment philosophy has risks. Some risk is necessary, after all, to make money. But for retirement plans under the scrutiny of Wall Street and shareholders, the growth of pension assets and liabilities has increasingly put the overall enterprise at risk.

The recent divergence of shrinking assets and growing liabilities has resulted in underfunded plans and threatened the competitiveness — if not the survival — of many companies. It's critical to control the impact on the enterprise while keeping costs down and the plan's human capital goals in sight.

The good news is that, with an integrated approach to measuring and allocating risk across the investment process, from asset allocation through manager selection, you can indeed manage risk.

Risk Budgeting

Although you can't control asset returns, you can control liability growth — but only in the context of benefit plan design. Yet, from an investment perspective, the relationship between the two (i.e., risk) can be managed, through "risk budgeting."

Completing the Risk Budget The risk budget should address two questions: How much risk should you take? Where should risks be taken to increase returns? Risk budgets must necessarily address liabilities. The key measures of risk are: Returns: total returns vs. growth in liabilities Risks: the potential for undesirable outcomes to the total plan (security of benefits, costs — both amount and timing — to sponsor) To complete the risk budget, you need:   Percentage allocation Detailed specification Policy   Asset classes Index Implementation   Manager types Mandate

In risk budgeting, you determine how much risk is "spent" on an investment program and allocate that risk among different areas. This means taking into account the governance and financial requirements of the program, and the attractiveness of various risk–reward opportunities and their interrelationship.

Page:      1   2

return to top