No pension scheme can afford to invest blindly without considering what would happen if something went wrong. But something could throw a spanner in the works at any given stage of a scheme's administration and investment processes. This is what risk management and budgeting is all about. But, as with any principle, there are those that lead and those that follow.
The approach of Austria's €233m multi-employer scheme Bonus approach to risk is an efficient but extremely comprehensive solution that leaves practically no stone unturned. Many questions are asked and IPE's judges recognise this separates Bonus from the pack.
According to Bonus, risk is "any unexpected divergence from target levels". There are risks that can be controlled and risks that cannot. "Uncontrollable risks must be avoided. These mainly involve operational and other risks as well as unexpected divergences in financial risks," the fund says. Nonetheless, Bonus says risk is inevitable. "There are no prospects without risk."
Bonus considers risk management as a process that can be split into distinct phases to enable the scheme to devise a solid risk management strategy. "The risk management process is regarded as an ongoing process. The aim is to identify and restrict potential risks early in order to create scope for action helping to safeguard existing commitments in the long term," Bonus says. The phases consist of:
So the strategy allows the scheme to identify the risks. Next, it analyses and evaluates the risk before deciding on how best to manage them and set up appropriate monitoring processes.
In addition, Bonus says risk communication and documentation form an integral part of all phases in its risk management process. The fund argues that an open communication policy is vital to the success of a risk management process and proper risk controls are simply not possible otherwise.
Bonus has devised a series of comprehensive and accurate ways to come up with exclusion criteria as well as back-up measure that it implements to minimise unexpected risks that it prefers to avoid.
In principle there are several different types of main controls that it employs to ensure it is successful in this endeavour:
Bonus says it calculates VAR at portfolio level each month. It gathers the underlying raw data largely on a daily basis from the fund managers. It calculates the variance-covariance matrix itself. In addition to VAR, Bonus has established risk ranges for asset allocation, volatility and key performance figures which are regularly reviewed in a standard way. It also then looks at and estimates the impact of interest rate changes and stress scenarios on the portfolio. Another means to avoid unnecessary risk, according to Bonus, is by avoiding the use of derivatives in its investments.
Getting round having to use derivatives has led to Bonus coming up with a new concept for its loan division. The aim is to provide cover for all the fund's future liabilities and introduce greater flexibility in the assessment of both individual risks and group level risks and the use of fixed interest securities to secure retirement income.
The first step saw the introduction at the end of 2006 of an overlay programme that used interest rate futures to offset against assumptions for the interest rate curve. Further assumptions were made for investment performance, market developments, the duration of the scheme and the level of pension income required. This led to the formation of a flexible benchmark covering flexible time periods in early 2007 for a fixed income mandate that has been separated into two parts.
HIGHLIGHTS AND ACHIEVEMENTS
Managing and controlling risk is essential but can be a very complex and time-consuming exercise that goes hand in hand with a scheme's everyday operations - from investments to administration. Where Bonus has seemingly got it right is its insistence on first breaking down every element of its operations and charting the risk each carries. This has allowed it to create a risk budget that covers everything it does and ensures it can run efficiently and confidently invest in areas such as interest rate overlay programmes, where most continue to tread carefully.