In Steven Spielberg's sci-fi thriller “Minority Report,” set in the year 2054, precognition appeared the perfect system to stop crimes before they happened. But as Justice Department agent Danny Witwer — played by Colin Farrell — pointed out, “There's a flaw. It's human. It always is.”
In the real world of 2009, some pension fund executives are wondering whether they placed too much faith in their systems — specifically their risk management systems — and not enough in humans.
More and more, the answer appears to be yes. And so, as a result of the credit crisis, some pension funds are adding more of a subjective element to their investment decision-making.
“When the correlation goes to one ... you don't throw away the models but it does emphasize the human judgment element, which is probably a lot more important (than in normal conditions),” said William Clark, director of the New Jersey Division of Investment, Trenton, which oversees $60 billion in assets.
Added Ramon Tol, global equity fund manager at Blue Sky Group in Amstelveen, Netherlands: “More human intervention, often referred to as judgmental overlay, in managing portfolios and stock selection, especially in these volatile times, may make sense because it is well known that most of the quant models are not equipped to deal with extreme volatility.” Blue Sky, which has $10 billion in assets under management, handles the KLM Royal Dutch Airlines pension fund.
However, all the human intervention in the world won't help unless risk managers find a better way to get their voices heard.
“Perhaps they (risk managers) should have had the guts to be more vocal. I don't know of any serious risk professional who was not very aware of the conceptual limitations of the standard risk models,” said Bennett Golub, vice chairman of BlackRock Inc., New York, with $1.3 trillion in assets under management.
But the conundrum facing pension fund executives and money managers remains: Should they listen more to their risk managers or beef up their models? Or both?