Pension plans, as they expand internationally are apt to run interest rate and other economic risks they don't know about, according to pension consultants who are introducing new software to spot those risks.
Typical plan and endowment executives soon are expected to be able to tell what kinds of risks they are running for their fund as a whole, looking forward and backward in time.
BARRA Inc., Berkeley, Calif., is nearing preliminary delivery of a forward-looking total fund risk analysis software. Wilshire Associates, Santa Monica, Calif., will introduce this month affordable versions of software that measures the total fund risk attribution.
Meanwhile, Ibbotson Associates, Chicago, is working on a total risk information for combined equity portfolios only; a total plan risk program is a possibility later on.
Total fund risk information generally is available now only for the largest banks and brokers, which are the only institutions that typically can afford it.
A measure of total fund risk is important because funds can have hidden risks when their portfolio is considered as a whole. Yet, none of the individual portfolios in a fund might show those risks because they are considered individually or in smaller groups, according to consultants.
Total fund risk measures are becoming increasingly important as institutional investors move into the international markets, where there are hidden undercurrents of risk because of elements of country relationships that aren't as readily discerned by outside investors.
Plan sponsors' ability to get a handle on a plan's total risk is sort of the "Holy Grail" for many institutional investors, said Paul Green, manager of strategic marketing for BARRA.
The desire to know a fund's total risk level became noticeable particularly in 1995, when several companies and pension funds lost hundreds of millions of dollars to derivatives.
BARRA has been able to identify risk levels for total equity portfolios through its Aegis global equity analytic system software and total fixed-income portfolios through its Cosmos global bond software.
A crucial step in determining total plan risk is the building of a mathematical bridge between the equity and fixed risk models used in analyzing portfolios, said Mr. Green.
Some plans probably are unknowingly exposed to sources of risk in the European and other international markets, he said.
"Three European managers come to you and say, 'We all expect to give you 12% returns a year based on past performance'. You engage them, but unknown to you they all independently make the same bet on a fall in German interest rates, which turns out to be incorrect, and so they all lose money," said Mr. Green.
To avoid that problem, a plan sponsor would have to assess their portfolio risks and make sure they weren't unintentionally intensifying a single bet.
Besides German interest rates, other factors that can affect multiple portfolios can be currency movements, exchange rate mechanisms or a bet on European economic recovery as a whole.
Algorithmics Inc., Toronto, and Bankers Trust Co., New York, do make total fund risk analysis tools to analyze total risk in real time. But, Mr. Green, said some real-time products are expensive for most plans because the software is aimed at large banks and brokers who buy and sell securities for their own account. One estimate puts the cost at more than $200,000 a year.
Mr. Green said he couldn't say, other than to say it would be more affordable, how much BARRA's total fund risk software would cost.
Hal Reynolds, a senior vice president and partner at Wilshire, said Wilshire's Compass executive information system offers total, planwide risk assessment.
Compass, a kind of consultant-in-a-laptop program, costs about $24,000 a year for Wilshire consulting clients and $36,000 a year for non-clients.
The Wilshire software doesn't measure risk real time. It does provide monthly data that allow investors to go back and look at the total risk of a plan.
"The idea of total fund attribution is fairly new. It analyzes how we have achieved our results, and how does it compare to other funds. (It tells) what are our competitive advantages versus other funds," said Mr. Reynolds.
With Wilshire's new software "you measure risks in the plan, and then you measure the return taking those risks. What you really want to do is eliminate those risks that you have taken that didn't offer a reward," said Mr. Reynolds.
Wilshire's Total Fund analytic will build peer universes for total fund and asset class return comparisons based on fund type, investment policy, implementation strategies and other information.
It also will perform total fund attribution and measure investment policy and implementation decisions, and analyze asset allocation, active manager strategies and cost structures of other funds.
Ibbotson's equity analytical risk system will be able to aggregate and analyze a large number of equity portfolios. Mike Henkel, managing director at Ibbotson, said the analysis will be useful for back-testing, optimization and attribution analysis.
Through the application of factor models, an investor using the system will be able to spot areas where the aggregate portfolios are overweighted and make adjustments.