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New model provides room to manoeuvre

With a capital value of €35.4bn, over the past year, the Danish superfund, ATP has modified its risk management process in two significant areas to meet its investment objectives. The result has been the in-house development of a new asset-liability model and the implementation of a new dynamic strategy within the fund’s asset allocation tailored to its ability to accommodate risk.
ATP believes that its new asset-liability model, which took two years to develop, will help mould its investment strategy to meet the fund’s long-term pension objectives. The model, which takes a 30-plus years forward-looking horizon, works by simulating a large number of possible eventualities in ATP’s balance sheet, therefore enabling the investment team to weigh returns against risks over both the short and long term.
Traditionally, ATP has collaborated with a large US bank to carry out its asset-liability analyses. However, it sees a number of advantages in not relying on external models. In practical terms, it says that the internal model can be used far more flexibly and frequently than external models. ATP views this as particularly significant during turbulent periods. The new ALM model has also not just encouraged a better in-house understanding of the issues involved in ALM, but the team believes that the quality of decision-making has also been improved. One need look no further than the fund’s new dynamic asset allocation as an example of this.
Two fundamental objectives figure in ATP’s risk management strategy. One is to maintain the long-term value of pensions for its 5m members and the second is to ensure that even in the short-term, reserves remain robust in the face of adverse financial market conditions.
In meeting its investment aims, ATP has introduced a dynamic principle into its asset allocation. When the fund’s reserves are high, ATP says it will make protecting the long-term real value of pensions its top priority. However, when reserves are low, it will focus on ensuring that these are able to withstand hostile market conditions, namely, to limit the risk of further short-term loss of reserves.
ATP’s revised risk management is driven by the view that asset liability management is dynamic, countering traditional ALM analyses, which take the view that asset allocation benchmarks are static, sometimes with limited annual revisions. Yet, as ATP argues, look at the last three years and this is shown rarely to be the case over more sustained periods.
In situations where asset allocation has to deviate from the long-term target, ATP says it is imperative to have the right guidance. By introducing a dynamic principle, which tailors investment risk to ATP’s ability to bear the risk, as defined by the fund’s reserve levels, it believes it has provided a unique solution.
Risk calculations are carried out on a daily basis, with guidelines determined by the board, using an adapted version of ATP’s new asset-liability model. The model now fulfils a vital part of the long-term investment decision-making process. It is the principal determinant in setting long-term targets for asset allocation such as foreign and domestic equities, fixed income and hedging of interest-rate risk. If risk is too great, investment risk is reduced by limiting the share of foreign equities in the benchmark, conversely however, if risk is low, the share of equities in the benchmark will be increased. ATP believes that it is therefore being pre-emptive in its risk management, by reducing risk in good time before any threat is posed to reserves without affecting its ability to actively manage the portfolio. It feels that these measures ensure that the long-term asset allocation target will eventually be reached when reserves are high.
In ATP’s view, the optimal investment strategy often differs in the short and long term, a problem common to many pension funds, which has a huge potential bearing on considerations of risk and return. It believes it has found an innovative solution when taking decisions about when to change the benchmark allocation and by how much.

Highlights and achievements
Established 40 years ago, this defined contribution fund is proud of its recent activities in risk management. It believes that the development of a new asset-liability model and introduction of a dynamic principle in the fund’s asset allocation is unique in the pension fund industry.
Keen not to be at the mercy of impromptu decisions, particularly in the event of a falling market, ATP has taken the bull by the horns in creating a framework, incorporating asset-liability analyses, which enables it to assess risk well in advance. ATP believes that this structured approach will stand it in good stead by increasing its ability to make consistent and prudent asset allocation decisions, particularly when reserves are exposed to a volatile marketplace. Moreover, it says it can now act with speed when a hostile environment demands a change in the investment risk profile without having to ‘reinvent the wheel’.

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