New definition of risk needed in challenging investment landscape

Investors need to be more risk aware and expand their idea of what risk is as they continue to seek returns in a challenging investment environment.

This increased risk awareness was the common thread running through the investing-focused sessions at Pensions & Investments' second annual Global Future of Retirement conference, held in New York June 15-16.

“We need to enlarge the notion of risk,” said Pascal Blanque, deputy CEO and global chief investment officer at Amundi Asset Management, in a discussion focusing on the reincarnation of diversification.

He said growth, inflation and market stress must be factored into asset allocations, since these are the macro factors that drive asset price dynamics. It is “simply wrong” that investors can make arbitrage plays across all asset classes, he said.

Risk-factor allocations outperform traditional allocations over the long term, and improve the efficiency of an investor's portfolio, added Mr. Blanque.

He also said foreign-exchange management is the most important aspect ofmanaging an investment portfolio, and moves in currencies could wipe out parts of returns.

Other risk focuses throughout the conference included geopolitical issues; environmental, social and governance risk; and liquidity.

Geopolitical events are “part of the continuation of globalization and the integration trend in the global economy,” said Gabriel Petre, lead investment strategist of asset allocation for the World Bank.

The potential for geopolitical events to affect asset performance are embedded into the long-term assumptions of the World Bank's $22 billion pension plan, he said in a session addressing geopolitical risk.

However, Mr. Petre said it is important not to overreact to these risks. “You have to know what your risk exposures are and how to protect them.” Short of a financial crisis of the order of 2008, “diversification will protect the portfolio.”

When a shock occurs from geopolitical or other risk factors, investors cannot afford to wait and see what happens, Mr. Petre said, adding “we have to think longer term. How will the world look beyond the initial shock? Do we see certain new opportunities that we need to think about over the medium and long term that we want to include in our portfolio?”

The issue of liquidity risk within fixed-income allocations ran throughout the conference sessions. Speaking on a panel of economists, Megan E. Greene, chief economist and managing director at Manulife Asset Management, said lower liquidity “is pretty much keeping me up at night. There is not a lot of liquidity; when investors decide to back out of trades they all end up stampeding for the door at the same time.”

Ms. Greene added that “when you have corrections, they are going to be big, and they are going to be painful.”

Risks associated with ESG were the focus of a keynote luncheon panel discussion.

“The goal is to have a tool to prevent an event that could cause risk,” said Mauro Bichelli, general manager of Italy's Fondapi Pension Fund, which has about 40,000 participants and e700 million ($785.4 million) of assets under management. He said the fund uses an environmental and governance benchmark for its ESG assets, which represent 4% of the portfolio. “I think the most important thing is, you want to invest in all the sectors,” he said.

ESG as an investment theme in itself has grown, with at least $4 trillion invested in ESG strategies. That represents “a tremendous change,” said Christopher Geczy, adjunct professor of finance at The Wharton School, University of Pennsylvania.

Robert M. Wilson Jr., research analyst at MFS Investment Management Inc., also sat on the luncheon panel. “ESG factors are increasingly becoming important in investment today,” he said.

Amundi's Mr. Blanque said in his discussion on diversification that ESG risks cannot be ignored for long-term investors. Amundi has about $1.2 trillion in assets under management.

When it came to where the next big investment destinations would be, several themes ran through discussions at the GFOR conference.

In the session discussing geopolitical risk, Marvin Zonis, professor emeritus, Booth School of Business at the University of Chicago, said as soon as sanctions against Iran are lifted, investors should put money to work there.

Slightly less esoteric was a push for investment in infrastructure. The first call came from M. Nicolas J. Firzli, director-general of the World Pensions Council and an advisory board member of the World Bank global infrastructure facility.

In a panel discussion of alternative investment options in defined benefit and defined contribution pension plans, Mr. Firzli said infrastructure remains on the fringe of institutional alternative investing, despite its increasing popularity and fast growth as an asset class.

However, as popular as infrastructure is becoming, it is “complex, fraught with risks, chief among them country risk,” he warned. That country risk, he added, may be one of the main reasons many asset owners hesitate to invest in infrastructure.

“If a country's regulators start making changes, you can't pick up your airport and move it to another country. There is a huge gap between talking about infrastructure and actually investing in it,” Mr. Firzli added.

The second call came from Laurence D. Fink, chairman and CEO at BlackRock Inc.

The $4.8 trillion money manger has about $6 billion in infrastructure, he said, but he wants that to increase to $20 billion to $30 billion.

“It's a major component for future growth” for the firm, he said. “More importantly, I look at it as a mechanism for us to be an impact investor in countries around the world.”

Mr. Fink said infrastructure investment is “a perfect marriage” between BlackRock's retirement and insurance company clients — who are “desperate for high-yielding long-duration assets” where “liquidity is not as important” — and society.

Increased interest in investing in alternative asset classes may present money managers with further opportunities on asset owners' behalf — despite increased interest from asset owners to expand their internal management capabilities in those areas.

In a panel discussion considering the changing role of the asset owner, Richard Young, a senior vice president at State Street Corp., said more than 80% of 134 asset recently surveyed by the firm expressed interest in expanding their internal management capabilities in the next three years. But he also noted that there was little evidence of a big push in that direction. n

Kevin Olsen, Hazel Bradford, Douglas Appell and Christine Williamson contributed to this story.