When executives at Qwest Communications International Inc. talk about embarking on a new journey with the company's $9 billion pension fund, they seek to explore a realm of splitting market risk from active risk, of transportable alphas, overlays and growing complexity in investment management.
Their guide is risk budgeting.
"Risk budgeting is a journey, a process," said Kim Walker, president, Qwest Asset Management Co., Denver, which oversees a total of $13.6 billion in assets, including the defined benefit plan.
The results could bring increased efficiency to asset management, more control over risk, and returns better able to achieve the objective of funding pension liabilities, she said.
"We view risk budgeting as a tool in the investment process," said Ms. Walker. "We adopted it because of the limitations of existing tools. Risk budgeting is a robust tool.
"I'd say we are early on in the process" of using risk budgeting. "We've been seriously doing risk budgeting since last fall."
Kurt Winkelmann, managing director and co-head of global investment strategies, Goldman Sachs Asset Management, New York, which works with Qwest on risk budgeting, calls it a "process of making sure a portfolio's risk allocation is consistent with an investor's investment views."
"Asset allocation and risk budgeting are closely related," Mr. Winkelmann said. "Risk budgeting reframes discussion from portfolio weightings to risk allocation."
Risk budgeting is getting more attention from plan sponsors now for several reasons — the biggest one being the search for alpha.
"Because we've come through several years of poor equity returns, people aren't as confident today" about expected returns on traditional assets, said Charlie Jacklin, president, Mellon Capital Management Corp., San Francisco.
Also, he added, "more plans have funding issues because of the fall in bond yields," and many pension plans today are underfunded or marginally funded.
"People are asking, ‘Where else can we add value?'" Mr. Jacklin said. "They talk about absolute return strategies, long-short strategies, global tactical asset allocation and currency overlay strategies as a source of alpha."
A focus of risk budgeting is "trying to get expected return for plans up without raising expected risk or increasing it modestly," Mr. Jacklin said.
"The trick to risk budgeting is correlation. Overlay strategies tend to have low correlation to beta (or traditional) strategies." For example, "putting on a global tactical asset allocation will increase risk, but not very much, because it has low correlation to other assets."
"Risk budgeting provides an ability to use more sophisticated strategies," Karyn L. Williams, vice president and principal, Wilshire Associates Inc., Santa Monica, Calif., concurred. "You can't use strategies like that unless you have tools to measure risk on a consistent basis.
"Risk budgeting puts sponsors in a position to relax a mandate because they have the tools to closely monitor a manager, which reduces risk."