ATP's successful risk management strategy comes from its strong understanding of how risk is central to good scheme management. This philosophy has allowed ATP, Denmark's largest pension fund, which manages almost €49bn in the public sector for some 4.4m active and deferred members and 600,000 pensioners, to embrace the much-hyped and debated concept of liability-driven investments.
"We believe that excellence in pension fund management requires a strong focus on mutual dependency between three key pillars: the scheme's objectives and risk tolerance; investments; and pension policy," the scheme says. "Risk management is the glue that holds these pillars together and a cornerstone in ATP's investment management. Liability issues have had a very substantial influence on ATP's investments and risk management for several years," it adds.
Liability matching has grown in Denmark, where schemes are required to take a mark-to-market valuation of their liabilities as well as their assets. "This was instrumental in determining the nature of many of the new risk-control measures that ATP introduced," ATP explains. Equally important was the scheme's decision in 2003 to implement a dynamic asset allocation strategy. This means investment risk is now directly linked to the scheme's reserves and the risk tolerance of its board. In the past year the focus of the fund's risk management has been firmly in line with its restructured business model which divides its investments into a straightforward investment portfolio and a ‘hedge' portfolio.
"The purpose of the latter is to hedge the ATP's nominal liabilities, while the investment portfolio is divided into beta and alpha portfolios," ATP says. ATP explains that the purpose of the beta portfolio is to explore general market risks, using its risk capacity to the optimum. ATP believes this can best be achieved through efficient diversification. However, the alpha portfolio aims to generate returns by taking risks that are practically, if at all, unrelated to the beta portfolio's equivalent.
The two portfolios are managed separately by different teams. "We believe that an organisation with clear roles and objectives fosters better risk management and more accountability," says ATP.
ATP believes there are two further areas in the development of its overall risk management strategy over the past year - managing and controlling risk in an integrated and consistent way, and maintaining support for any decisions in either the investment or hedge portfolios that make full use of ATP's risk capacity.
"If we put these areas into context, ‘integrated' means taking everything on the balance sheet into account while ‘consistent' refers to the fact that the same methodology applies to both portfolios and our liabilities," ATP says.
But it doesn't stop there. ATP is a forward-thinking fund and moving from a benchmarked-based investment strategy to one that favours absolute returns means developing an absolute risk measure. In addition, using derivatives means it is not relevant to use the invested amount figure in the denominator when measuring performance. The risk capacity is effectively the only limiting factor and ATP says returns must be measured against risks.
So how is the risk tolerance determined? The scheme's board sets risk tolerance in relation to the maximum probability of ATP suffering a certain loss of equity capital - which the fund calls ‘bonus potential' - over a set period. The absolute risk is measured as a version of ‘economic capital', which the fund has developed over the past year and refers to as risk capital.
"This is the minimum bonus potential from all the investment risk that keeps the scheme within its tolerance limits," ATP explains, adding that the actual risk budget is the maximum it allows for the risk capital, which is currently less than the bonus potential. 

ATP calculates stress scenarios using the fund's internal asset liability model which covers the balance sheet in full. The ALM is constantly being reviewed, ATP says. Last year it was refined to take account of new asset classes. Undertaking an ALM now benefits from the fact the asset managers, actuaries and analysts were brought under the same roof in 2005.  The fund uses risk capital, VAR and expected shortfall in its management, but these need to be supplemented by other risk measures.
In addition, there are a set of limits controlling counterparty risks. In total more than 500 lines of risk are monitored on a daily basis.
Decisions for different parts of the investment process are taken separately and ATP determines tolerance to match each part, including that there are lines for different risk budgets, lines for the risk arising from exposure to different asset classes and lines to accommodate specific risks, such as interest rate risk.
Decentralising decision-making in this way demands a high standard of operational risk management, ATP says. So the risk strategy depends on certain core principles, including clear corporate roles and objectives, clearly established risk limits, a central booking system for trade positions which must be updated daily and priced on a consistent basis. Moreover, the strategy must cover everything consistently within one framework and risk is calculated daily.

Highlights and achievements
ATP's approach to risk management is comprehensive, focused and flexible. A clearly thought-out management process has allowed the scheme to experiment with alternative asset classes and investment solutions.
Its decentralised approach allows it to concentrate on different areas separately but under the watchful eye of the board, whose proactive input ensures the scheme's risk tolerance can be adjusted so that ATP can make full and efficient use of the capacity this tolerance allows.
But what is particularly impressive is how ATP understands that its risk management policy doesn't start and end with investments but is an essential part of the overall management of the scheme and its objectives.