Consultants are hoping to make investment risk as clear - and as important - an issue to most pension officials as investment performance.
The analytical service division of banks and consultants are building or already have services that will identify and relate plan risk to likely economic scenarios, relate risk to plan objectives, and better relate investment performance to the level of plan risk.
The Northern Trust Co., Chicago, is using value-at-risk methodology to develop risk tools. It expects to make them available to clients later this year. (The value-at-risk concept tries to put a dollar value on the expected losses a portfolio might experience under a given scenario.)
BARRA Inc., Berkeley, Calif., has just begun offering a subscription service that provides reports on total risk of a plan.
Bankers Trust Co., New York, has reduced some fees for its existing RAROC (Risk Adjusted Return on Capital) product. The product, used for years in investment management at Bankers Trust and other management firms, has been modified to fit pension fund needs.
Some consulting divisions of major master trust banks and software analytical shops reportedly are spending a significant amount of money to build new tools to measure risk for pension funds. But one consultant said some bank officials are trying to price their risk tools with the question in mind: "Will clients be willing to pay for it?"
Some bank officials say a few very large pension funds are asking for the new risk tools. They hope the tools will be hot sellers with smaller plans as well.
Some tools will tell pension executives the risks of falling short of objectives under different economic scenarios. The tools will tell which portfolios or which managers are producing the risks under different scenarios.
Consultants expect that new risk issues confronting pension executives will make them want more accurate readings on plan risk.
One issue is performance reporting. Some pension fund executives believe universe comparison measures are unfair because they compare performance and size of assets but don't compare the risks funds are taking. A pension fund taking greater risks in the equity markets during a booming market can look far superior to a fund playing it safe, some argue.
But officials say defining risks in a plan is difficult. The new technology will give plan sponsors a reading on the riskiness of their plan, and possibly a way to compare it to other plans.
Another risk issue is the heavy investment of some pension funds in the equity markets. Those funds could face a mismatch between assets and liabilities if recession begins, according to consultants.
Another risk question is plans' ability to detect embedded options in portfolios. Plan executives will want to know how the options, currency exposure, futures and forwards will react to changes in interest rates and how the whole plan would be affected.
Some plan executives are worried about the risk of an economic recession, said Michelle McCarthy, a managing director at Bankers Trust.
Plans have been getting "fantastic returns" from the equity markets, she said. But in an economic recession, plan liabilities could rise and investment returns could fall because of a drop in interest rates.
Plan executives would be hit with a "double whammy," she said. A pension executive's ability to clearly identify risks would help in managing cash flow in the current year, she said.
"Plan sponsors are trying to get their arms around risk in their portfolios because of a number of things that have happened in recent years," said Eliza Spain, a senior vice president at Northern Trust.
Many pension executives have riveted their interest on risks connected with compliance monitoring in recent years, she said.
But some plans now have expanded their interests in risk "to the next level," she said.
Northern Trust is working with a couple of its clients, which she would not identify, to consider various value-at-risk methodologies that are appropriate for pension plans, she said.
"We think at this point, the jury is still out," she said.
Northern Trust wants to make value at risk a meaningful concept to pension executives whose plans have long-term horizons. A meaningful risk system, she said, would compare risk to "something clearly," she said, such as liabilities or objectives.
Another concern is cost. Northern Trust wants to provide a system that is affordable, she said.
"There is no question" the pension plan community is moving in the direction of increased focus on risk as well as investment performance, said Tom Herndon, executive director of the $80 billion Florida State Board of Administration. He said his plan uses many tools from BARRA to measure risk.
BARRA recently showed its total plan risk service to clients at a seminar.
"We are ready to sell it as a service. It is not ready yet as software," said Paul Green, manager of strategic marketing for BARRA.