Institutional investors are moving away from piecemeal approaches to make the conscious management of planwide risk the guiding principle for boards of trustees, investment consultants say.
Risk has always been in the background as investors pursued their return objectives, but today a growing number of large plan sponsors “are putting total fund risk management systems and processes, and risk-focused governance principals in place for the first time,” said Karyn L. Williams, a managing direct and principal with Wilshire Associates Inc., Santa Monica, Calif. That evolving approach includes explicitly stating risk objectives in the investment policy statement, said Ms. Williams.
For example, at the end of an iterative, extensive process to determine its comfort level with the risk implications of the plan's return objective, a board can say “we hope to achieve X% returns, with a standard deviation of roughly 12% (and) our comfort level with downside loss is 20% in any given year,” Ms. Williams said.
If a higher return is needed, the board has to deal with the risk implications, or come to grips with the bigger contributions needed to make up the difference, but that debate will benefit from great clarity about the trade-offs involved, consultants say.
To make a comprehensive risk management system function properly, “the trustees must own the framework,” agreed Bruce Curwood, Toronto-based director of investment strategy with Russell Investments.
In the environment evolving now, increasingly trust-ees will establish clear risk parameters, stress test their portfolios under a range of different economic sce-narios and determine ahead of time just how much pain and volatility they're willing to accept in the short term.
Those goals won't lend themselves to off-the-shelf solutions. With each plan's circumstances, and relation to its sponsoring organization, unique, there's no cookie-cutter approach to putting a risk management system in place, said Mr. Curwood.
Another key element in configuring an appropriate system is “explicitly stating an overall alpha risk budget — how it will be generated, and how it will be monitored proactively,” said Ms. Williams.
Market players say high-powered risk analytic tools — previously the domain of investment banks — will contribute to that oversight, if properly used.
“What has evolved out of this crisis is a next-generation of plan sponsor that recognizes the need for integrated decision frameworks which include total fund risk systems, risk processes, and risk-focused governance,” said Ms. Williams.
But, she added, that work requires commitment, resources and education. “I expect to see it evolve differently across plans,” she added.