GLOBAL - Most European pension funds have a "blinkered view" of their risks, according to a survey by the EDHEC Risk Institute.
EDHEC's survey found that accounting risk - the volatility from the pension fund in the sponsor's books - is managed by only 33% of respondents, while more than half ignore sponsor risk, or the risk of a bankrupt sponsor leaving a pension fund with deficits.
The survey also found that most schemes in Europe fail to assess the adequacy of their asset liability modelling, which could lead to "sub-optimal decisions being taken again and again", EDHEC said.
Samuel Sender, applied research manager at the institute, said the first challenge for a pension fund was meeting its liability by hedging it away, fully or partially.
The survey showed the liability-hedging portfolio at 45% of pension funds was "modelled imprecisely".
The second challenge, he said, was to gain access to performance through optimal diversification within and between asset classes.
EDHEC's survey found that most respondents currently use market indices to define investment funds' benchmarks, even though "market indices are weighted by capitalisation and are known to be highly inefficient".
The last challenge, according to Sender, is for pension funds to respect their minimum funding ratios by insuring away risks.
EDHEC said nearly a third of respondents used risk-controlled investing (RCI) strategies to manage prudential constraints, whereas more than half (56%) use economic/regulatory capital.
"Like RCI, economic capital relies on the measure of a risk budget and of a surplus," the institute said.
"Economic capital, however, involves a discretionary, rather than rule-based, investment strategy, and possible delays."