NEW YORK -- Novartis Corp. has begun using value at risk and other risk management techniques for the company's $2 billion 401(k) plan.
The use of VAR in analyzing a defined contribution plan is unusual, but not unique, according to risk experts.
"It places them in the league of the very few firms who have begun to use things like allocation of risk," said Tanya Styblo Beder, principal with Capital Market Risk Advisors Inc., New York.
While many pension executives are still considering the usefulness of VAR for managing defined benefit assets, Novartis is applying the strategy to its 401(k) plan. (Bankers Trust, Novartis' defined benefit custodian, already assists Novartis with risk management for its $2 billion defined benefit fund.)
The process would be much more difficult, though, if Novartis used mutual funds as options in its defined contribution plan. The plan instead uses commingled funds, separate accounts and unitized separate accounts.
Novartis already uses Alerts, another risk management tool, for monitoring defined contribution portfolios.
Alerts is an investment compliance service offered by the fund's custodian, The Northern Trust Co., Chicago.
Novartis also is using "normal portfolios" in evaluating its fund's investment managers.
"Two or three years ago, it was risk monitoring. Today, it's 'how do we manage risk?' " said William McHugh, vice president and treasurer at Novartis.
Risk monitoring came into vogue after a slew of unauthorized trades at various financial institutions led to billions of dollars in losses in 1994 and 1995.
Risk management takes it a step further by applying the risk monitoring techniques in the construction of an investment portfolio.
"At the end of the day, we want to have one common language, one way of looking at" the company's defined contribution managers and portfolios, and strong risk management is a way to get closer to that goal, Mr. McHugh said.
'So far ahead'
Moreover, Novartis pension executives are seeking consistency in selecting, evaluating and monitoring managers, another benefit to using a standardized risk gauge like VAR.
"Novartis is so far ahead . . .," said Donald S. Rieck, who is manager of Northern's integrated risk group.
Northern will calculate value at risk on a quarterly basis for each of Novartis' defined contribution managers for various benchmarks, and for the plan's options as a whole.
The process is simplified by the fact that Novartis doesn't use mutual funds, although it does use commingled funds.
VAR analysis would be impossible unless the mutual fund managers were willing to share their holdings information more frequently than they are required to do, Mr. McHugh said. Even with commingled funds, getting holdings data can be an issue.
"The key to the whole thing is getting monthly portfolio holdings from the investment managers," said Adele Heller, managing director for BARRA RogersCasey, Darien, Conn.
Doing that with mutual fund managers is not that easy, but it's not impossible, Ms. Heller said.
For defined contribution plans she's worked with, it can take good, strong negotiating skills or existing relationships to get a mutual fund manager to deliver a monthly holdings report, she said.
A preliminary VAR report will be produced by Northern for the fund's 1998 fourth-quarter returns and a full one for the first quarter of this year. Northern offers the report in hard copy or via the Internet.
Mr. McHugh said he's not expecting any surprises.
"We have a good idea of the risk our managers are making" by way of BARRA Inc.-produced factor analysis, he said.
VAR will be used a number of ways in the defined contribution plan: as an absolute gauge of risk; to track risk over time; and to measure risk relative to benchmarks, Mr. McHugh said.
Novartis executives will look at the total risk of each of its nine defined contribution options and at each manager's portfolio, Mr. McHugh said. Novartis uses multiple managers for the five plan options that are actively managed.
Unlike its defined benefit plan, however, Novartis' 401(k) plan won't be tracked for risk at a total plan level, because participants decide the allocations, Mr. McHugh said.
If there is a big change in risk as tracked by VAR -- such as a manager making overly concentrated investment bets -- Novartis executives would tell the firm to "rein in the risk," he said.
The same would hold true if a manager were not being aggressive enough, he said.
Novartis executives also would shift allocations of managers within investment options were VAR to indicate that risk was getting out of line, he said.
Novartis executives expect to get more out of VAR in the future. "The information becomes more meaningful to us (after) we have a little history behind it," Mr. McHugh said. "I think it's going to become a more powerful tool for us."
VAR also will be calculated on each manager's normal portfolio -- a benchmark portfolio constructed out of the manager's expected universe of stocks -- and on more traditional benchmarks.
With that information, Novartis executives will use VAR to track how much risk Novartis' external managers are taking relative to the market.
The combination of tools available to Novartis gives fund executives a lot more information to use in evaluating managers, Mr. McHugh said.
"Hopefully, we will know a lot more than their average client," he said.
The fund's external managers generally are familiar with the concept of normal portfolios, he said; value at risk hasn't caught on as much, but is gaining acceptance.
"Unfortunately, different managers calculate VAR in different ways," he said.
Novartis executives haven't yet had the opportunity to sit down with any of their external managers to specifically discuss VAR, because of the newness of the information.