NEW YORK -- General Motors Investment Management Corp., in a series of small steps, is moving toward using risk budgeting in its asset allocation of the $91 billion General Motors Corp. pension fund.
Executives are working toward creating tools for modeling the asset allocation from the assumed alpha -- excess return -- each investment area is generating.
GMIMCo has a strategic policy mix, with an understanding of how much alpha it expects to get from each strategy and an eye on drifts from the planned asset mix.
"It's not true risk budgeting; we are monitoring our forecasted alphas by strategy," said Michael Clougherty, the new director of risk management.
When there is drift from the planned investment policy, the firm uses derivatives to tactically rebalance its asset mix.
GMIMCo uses risk building blocks that were put in place by Des McIntyre, who was head of risk management before being promoted to chief financial officer of GMIMCo last year.
It uses a top-down approach, first looking at best practices from other sources such as the Group of 30 recommendations and the 20 recommendations from the Risk Standards Working Group.
"The first point is to understand your risks," said Mr. Clougherty. The company monitors risks in every area including compliance, modeling, credit, counterparty, market and liquidity risk. It puts forth selection criteria for new products and management objectives, as well as performance measurement and benchmarking for all risk activities.
"A risk framework and risk building blocks -- we've had them for years," he said, noting the work of Mr. McIntyre. "There's an ongoing reassessment, not just at the trust level, but at the client level." By "clients" he means six plans overseen by GMIMCo: four plans for hourly and salaried workers and two plans for the Delphi Auto Systems Corp.'s hourly and salaried workers (GM spun off Delphi last year but is still managing the pension funds).
"It's a concept that has to be worked into slowly," said Charles Tschampion, managing director of investment strategy and asset allocation at GMIMCo. "Risk budgeting has a lot of elements to it and you can't do it in one fell swoop."
Broad policy mix
In terms of asset allocation, the firm has established a broad investment policy mix, using "an efficient portfolio on an efficient frontier," said Mr. Tschampion. "We're trying to actively add value when we put together asset classes.
"My budget has an overall risk that we want to take. We take it in the areas where it will do the most good," said Mr. Tschampion.
The funds use a large number of models that give off signals about where the best investments are and where it is best to take the highest level of risk.
The model could say one country's stock market is a better investment than another's. Depending on the models, the funds put their highest exposures where the model is giving the strongest signals.
Mr. Tschampion explained the model might signal it's time to have 50% of the risk coming from currency exposures and 25% from equity exposures, rather than the reverse.
He said GMIMCo developed a global asset allocation benchmark of 60% stocks-40% bonds, and might go to a 65% stock exposure.
"That particular exposure takes on a certain amount of risk," Mr. Tschampion said.
Different amounts of risk can be taken by overweighting or underweighting investments in various countries, he said, adding that the funds currently underweight the United States and overweight Japan.
But he declined to give any other current investment strategies, pointing out the models change from month to month and he didn't want to focus on "individual bets" that the funds had taken.
The firm watches key elements that are part of investment risk, including tracking error.
"We look at things like tracking error for every major investment strategy," said Edward Sullivan, director of investment research for GMIMCo.
The company separates its investments by risk-return characteristics. There are seven categories of U.S. equities based on a risk-return profile, segregated by capitalization, value and growth characteristics; three categories of international equities -- Europe, Far East and emerging markets; and three categories of bonds -- high quality, high yield and international, according to Mr. Sullivan.
How much is too much
The company asks: "Are we taking too much risk or not enough, based on the expected alpha?," said Mr. Sullivan.
The firm also looks across managers at the target alpha for the total fund , "to see if we are taking enough tracking error or too much. We see the risk process as a complement to our investment process," he added.
Mr. Tschampion said the funds allocate their assets using the "information ratio" -- the ratio of excess return to tracking error.
An example: Using standard deviation, if a portfolio had 300 basis points of tracking error, the return of the active investments would be plus or minus 3% over or under the benchmark. That would give an excess return of 1.5% and an information ratio of 0.5%.
Any investment with a positive information ratio is good, because it indicates the funds are generating the smallest amount of volatility and the highest amount of alpha. As long as there is a benchmark with which to compare it, the information ratio can be measured for an individual manager or the entire funds, according to Mr. Tschampion.
"We want to keep tracking error consistent with the expected alpha," said Mr. Sullivan. "Then we look at information ratios."
The funds are using small exposure differences to consistently add value, rather than taking on a lot of risk. "We have a very good handle on the risks we're taking," he added. The firm also makes sure it is "efficiently allocating risks and that things don't slip through the cracks."
"We may take more risks on certain pieces (of the portfolio) when we know we have control (over it)," said Mr. Tschampion. "We take more risk where we feel we can add more reward."
GMIMCo uses derivatives-listed futures to rebalance its portfolio.
Listed futures help
Mr. Clougherty said it can be difficult to reallocate strategies and move dollars around, but GMIMCo's use of listed futures makes it much easier."They're a low-cost, liquid, efficient way to rebalance (assets) using the derivatives market."
Mr. Tschampion concurred, saying the tactics used by the company "are futures-based strategies. We use futures to rebalance and also to equitize or `bondize' cash to be as fully exposed to the benchmark as possible." Using "plain vanilla" tools such as listed futures makes sense for the plan because "they're a very low-cost tool for doing a lot of things we need to do in risk management," he added.
Among the advantages, listed futures allow the funds to get exposures to particular investments at a lower cost and at less risk than using the cash market and buying or selling the underlying securities.
To measure the risk of investment strategies and to monitor and manage risk within the investment process, GMIMCo uses some BARRA modeling tools -- "strategy- and asset class-specific risk tools," according to Mr. Clougherty.
The company also uses Salomon Brothers' Yieldbook tool, which "gives a risk profile by sector and allows us to do attribution," he added.
"The biggest issue with risk tools is (measuring) enterprise-wide risk," said Mr. Clougherty. Getting the specific data and the integrity of the data "are driving forces" getting an enterprise-wide risk perspective, he said.