When it comes to implementing risk factor-based investing, no two early adopters are using the same approach.
What pension funds share is the need to generate returns to meet funding requirements in the face of an extended low-return environment, said sources.
Risk-factor investing is alluring: Moving 10% of a traditional asset allocation to such an approach would yield about 100 basis points of additional return per year and a 20% assignment would yield about 200 basis points with lower volatility, specialist risk consultant and investment outsourcer QMS Advisors, Lausanne, Switzerland, estimated in a paper on its website.
But how the first generation of risk factor-based investors has approached portfolio construction varies widely.
Pensionskassernes Administration A/S, Hellerup, Denmark, for example, began its risk-based investment program with a pilot project in 2010, restructured the entire equity portfolio along risk lines in 2012, and has since extended the approach to its commodities, currency and fixed-income portfolios, said Nils Ladefoged, senior portfolio manager. PKA manages 212 billion Danish kroner ($31 billion) for three Danish labor unions.
The $9.3 billion Missouri State Employees' Retirement System, Jefferson City, on the other hand, made the shift in 2012 from “a world where capital is allocated based on expected returns to one where capital is allocated on expected risk and economic balance,” said Rick Dahl, chief investment officer, in the fund's 2014 annual report.
MOSERS' shift, which was completed in 2014, converted 80% of the portfolio to a risk-based approach, exempting only the illiquid securities portfolio, which accounts for 20% of plan assets.
Nearly all risk-factor investors use external managers in some capacity, sources said, but the most common first step is to invest in a money manager's risk-premium strategy.
The $14.5 billion New Mexico Public Employees Retirement Association, Santa Fe, for one, recently allocated $400 million to AQR Capital Management LLC to run in a risk factor-based portable alpha strategy, replacing a portfolio managed by 15 hedge funds, said Jonathan Grabel, chief investment officer.
The $35 billion Arizona State Retirement System, Phoenix, uses risk factor-based exchange-traded funds from BlackRock Inc. to run a $400 million overlay on its equity portfolio, which has a policy target weighting of 58%. The system also relies on the Barra unit of MSCI Inc. to assist with risk-factor identification and Nomura Securities Co. Ltd. to advise on global macroeconomic conditions, said David Underwood, the system's assistant chief investment officer.