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ABP and CalPERS boost for risk budgeting system

The recent purchase of sophisticated risk management systems by two of the world’s largest pension funds is likely to boost the adoption of risk budgeting in Europe and the US. The California Public Employees’ Retirement Systems (CalPERS) and its Dutch equivalent ABP have both bought the TotalRisk System, a leading package for analysing and controlling investment risk from California-based Barra.
This gives them the tools to pursue more advanced risk budgeting strategies and where these giants lead other funds tend to follow.
Risk budgeting requires a fund to be able to capture and aggregate exposures across its investments and to identify sources of risk. TotalRisk provides a broad set of functionality for collecting and managing portfolio data as well as a range of analytical tools.
“With TotalRisk, we can proactively manage our total risk and our active risks against benchmarks and fund guidelines,” says Thijs Coenen, head of risk management at ABP Investments which manages ABP’s assets. The fund holds a broad and complex set of assets including US fixed income, alternative investments and derivatives.
“Consequently, we required a system that accommodated our diverse asset base and could provide state-of-the-art risk analytics, models and functionality for these assets on an enterprise level,” said Coenen. ABP plans to use TotalRisk’s tools decompose risks, run stress tests and Monte Carlo and parametric value-at-risk simulations.
Like ABP, CalPERS wanted a risk management tool that could measure the fund’s aggregate risks across all asset classes and provide it with a mechanism to monitor and control the associated risks. “We were also looking for a risk methodology that would enable CalPERS to calculate value-at-risk, build scenarios, and stress-test our holdings,” said Patricia Pinkos, senior principal investment officer for CalPERS risk management and asset allocation in California.
Risk management systems such as TotalRisk are common on the sell-side - TotalRisk was in fact originally developed for banks - but have only more recently moved into the buy-side.
Barra converted TotalRisk for the buy-side in conjunction with Boston-based Putnam Investments. The company claims that its multi-factor analytical approach is more suited to the buy-side than the simulation approach of its competitors that focus on the banking market and that it offers the tools for a risk budgeting approach.
“TotalRisk provides flexible risk analysis that allows an institutional investor to view their risk both in absolute terms and relative to a strategic benchmark,” says Aamir Sheikh, executive vice president of Barra. “Risk can be decomposed into risk from asset allocation and asset selection decisions, allowing for a comparison of the current risk profile with the desired risk profile of the investor. Similarly, absolute and relative risk can be flexibly decomposed along many dimensions, such as asset class, country, manager etc., and the contribution to risk from different sources can be identified. This can then be aligned with return contributions to potentially achieve a better risk return trade-off. Alternatively, implied alphas can be computed along similar dimensions to look at the returns implied by the current asset allocation and portfolio management decisions. These can validated against the actual return expectations to see if the risk profile correctly reflects the beliefs of the investor as well as the constraints faced by the investor.”
But systems like TotalRisk don’t come cheap. Barra did not give the value of the deals with ABP and CalPERS but major risk management systems installations frequently cost over cost £1m (EXxm) or more. Few pension funds have the budgets for such systems or the IT staff to run them. However, modern computing and communications technology, particularly the internet, is providing alternative ways to access to risk technology.
Barra, like several of its competitors, has made its system available online as a bureau service, or application service provision (ASP) to use the latest computer jargon. Under this arrangement, a fund sends Barra its positions and the company runs the data through its analytics and sends back the results. Not only is this far cheaper as it operates on a pay-as-you-go basis, but it leaves Barra to manage all the complexities and upgrades of its technology. New York City Retirement Systems was one of the first to sign up for Barra’s bureau service last year.
Rival risk management system supplier Askari also offers its analytics as an ASP. The company is owned by leading US custodian State Street and a number of its customers now also make use of the Askari risk analytic service since the bank already has their portfolio data. Deutsche Bank also offers a similar online service, called db RiskOffice, to its custody customers and others.
With ABP and CalPERS giving the stamp of approval to modern risk management technology and the emergence of accessible and relatively cheap online risk services through ASPs, European and US pension funds will have the encouragement and the tools they need to adopt more risk budgeting strategies.

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