Public funds seeing merits of do-it-yourself approach

Heightened concerns over portfolio risk caused by the coronavirus pandemic may be the final push U.S. public pension plans need to take a more hands-on approach in their risk management process.

While U.S. pension funds have historically been more reliant on investment consultants for risk management, these plans "are realizing in a world where you are stuck at home, it's really prudent to have your own technological capabilities that can give you a real-time understanding of where your fund is and where it's going," said Ashby Monk, executive and research director of the Global Projects Center at Stanford University.

Over the past five years, asset owners in Australia, Canada and Europe, for instance, have all undertaken massive projects to insource data and analytics as it pertains to risk management of their investment portfolios, Mr. Monk said. In comparison, "the U.S. pension space is a little behind," he noted.

"In America, the endowments don't rely on the consultants as much as the pension plans and this is where you are seeing a wave of 'technologizing'… The last wave would be the U.S. pension plans, starting probably now," Mr. Monk added.

Mr. Monk co-authored the book, "The Technologized Investor: Innovation through Reorientation," with Global Projects Center research engineer Dane Rook, which highlights how long-term investors can use technology to better understand risk and the long-term behavior of assets.

"Being a long-term investor is not an excuse for (not) having a real-time understanding of your liquidity profile, your unfunded commitments, your pacing, your cash flows and so on. For instance, to avoid breaking through certain asset allocation thresholds, sometimes these long-term investors do need to move quickly to rebalance in volatile markets. And they simply can't wait for their consultants and calendars to align in order to do this," Mr. Monk said.

Laurie Martin, CIO of the $37.7 billion Connecticut Retirement Plans & Trust Funds, which consists of six state pension funds and nine state trust funds, said in an email that U.S. pension plans should have had risk management technology in place prior to the pandemic. But she believes "this will prompt those that did not have this capability to adopt it."

She confirmed that CRPTF internally oversees portfolio risk through third-party risk management technology.

"As fiduciaries of plan assets, public pension plans must understand all the risks that impact the assets and liabilities of the plan," she said. CRPTF uses third-party software to analyze risk across its portfolio "with security level detail," and also uses the technology to stress test the portfolio for various scenarios, such as interest rate changes, currency fluctuations and significant equity market fluctuations, she added.

"Additionally, we receive reports from our consultants and external money managers with regard to capital market assumptions and asset class correlations; among other reports. We also use third-party software to monitor the pension liability risk. This system allows us to analyze the impact of actual results vs. actuarial assumptions prior to the formal valuation reports being prepared. We can model different investment returns out into the future to assess the impact on the funded status of the plan," Ms. Martin said.

Rachel Wray, an Oregon State Treasury public information officer, also confirmed in an email that the state treasury's investment division "has been internally managing risk for numerous years with a dedicated team focused on risk management and utilizing external tools," such as BlackRock Inc.'s Aladdin, which it has used since 2015.

The state treasury manages the $74.1 billion Oregon Public Employees Retirement Fund.

Some pension fund officials have said their preference is to outsource risk management, however, for various reasons.

The $18.1 billion Kentucky Retirement Systems, Frankfort, does not currently run any risk management software in-house and prefers to let its investment consultant manage those responsibilities, CIO Rich Robben said in an email.

As of June 30, KRS had $12.7 billion in pension plan assets and the remainder in insurance plan assets.

"As a long-term investor, and having the preponderance of our assets managed by external managers, my feeling has always been that while stress testing the portfolio is interesting, it's not really actionable for us in the short term. For plans that manage more of their assets in-house, I do think (risk management software) can provide some benefits in terms of identifying unintentional risks, and quickly mitigating them," Mr. Robben wrote.

Donald C. Kendig, retirement administrator of the $5.2 billion Fresno County (Calif.) Employees' Retirement Association, said in an email that, generally, risk management is handled by the pension fund's active managers and evaluated at the total portfolio level by its general investment consultant, Verus Advisory Inc., Seattle.

Douglas Kidd, an investment officer at FCERA, also said in an email the pension fund's portfolio is "fairly simple, and we are not yet doing much in the way of tactical adjusting to the portfolio."

But Mr. Kidd has looked into risk management technology, such as BlackRock's Aladdin and Fidelity National Information Services Inc.'s APT solution. Mr. Kidd said that he does "hope to find a way over time to incorporate some of those features, but they are very expensive, and I do not yet see how we can use them to actually modify the portfolio."

Robert Nelson, associate director, institutional at Cerulli Associates Inc., Boston, said in a phone interview that, with its Aladdin platform, New York-based BlackRock has "grown very impressively over the last few years as investors have become more and more dependent on the risk management tools and services they provide."

Aladdin has also helped deepen BlackRock's relationship with asset owners, and served as a client-retention tool for the firm, he added.

Mr. Nelson noted in a follow-up email that Cerulli thinks of technology offerings as "sitting outside the core revenue engine of most asset management firms, but obviously BlackRock is a little different given their size and scale and successful analytic tools such as Aladdin."

"They've successfully started to monetize these tech offerings and are growing that side of the business rapidly. Others have not had the same success and thus lack the pricing power that BlackRock enjoys. While this is a fast-growing revenue segment for Blackrock, it is still a small portion of overall firm revenue," he added.

Back in June, Robert Goldstein, senior managing director, chief operating officer and global head of the BlackRock's solutions business, said during a Morgan Stanley conference that revenues from the financial technology business had grown at a 15% compounded annual growth rate over the last five years and were approaching the $1 billion mark.

BlackRock's Aladdin tools bring in the majority of its technology revenue, two sources familiar with the matter confirmed.

Sudhir Nair, managing director and global head of the Aladdin business at BlackRock, said in an email that, "Market shocks and volatility underscore the need for robust enterprise operating and risk management technology."

"We believe the pandemic will accelerate the shift from fragmented technology systems, to unified technology platforms like Aladdin that can support the increased need for risk transparency across asset classes and the construction of resilient portfolios," Mr. Nair added. "Aladdin is highly configurable to serve the needs of different client types including pension plans, insurance companies and asset managers. For clients who outsource investment management to BlackRock, Aladdin is a key differentiator of our OCIO offering."

According to Mr. Nelson at Cerulli, money managers with the scale or size to build out the technology side of their organization and provide something akin to Aladdin will gain a competitive advantage in today's landscape.

This was the case with State Street Corp., Boston, which in 2018 acquired Charles River Development, taking on the firm's front-office systems to complement State Street's capabilities for a global front-to-back platform for money managers and asset owners.

But, with margins tight for many firms, implementing such technologies to compete could be a challenge for smaller to midsize managers, he added.

"In some instances, that may lead toward more M&A activity amongst managers so they can get that scale that's needed to compete with the largest and most successful asset managers that are in the market today. Or you may see, not manager-to-manager M&A, but more instances like State Street and Charles River where (managers) buy a technology company to get these value-added services," Mr. Nelson said.

State Street did not respond to a request for comment.

Else Braathen, a Copenhagen-based product manager for risk management and forecasting at SimCorp A/S, which provides risk management technology for asset managers and asset owners, like pension, insurance and sovereign wealth funds, said that as a result of the pandemic, money managers have paid more attention to stress testing investment portfolios for worst-case scenarios.

Furthermore, ensuing volatility has caused money managers to face more scrutiny from investor clients, as firms are being asked to provide more ad-hoc and custom reporting on investment portfolios, a new report commissioned by SimCorp and published by Clear Path Analysis, a London-based market intelligence firm for the institutional finance industry, found.

"Due to the volatility, there is an expectation of real-time investment transparency, and that means firms must be able to quickly and accurately give details on how a portfolio — or indeed the whole firm — is faring (whilst of course adhering to regulatory requirements around reporting itself)," the report said.