Wasserdicht Pensionskasse in Frankfurt invited me to talk to them about risk. ‘You can tell us what you think we should do and what you think best practice should be in terms of risk management. And we have asked an EU regulator to talk to us. You will like him'.

So I explained what we, as a Dutch pension fund, were doing and how we might change a few things. ‘So Pieter you will still appoint external managers and you will not insist on them having a dedicated risk officer?' ‘Well no, sometimes this falls within the remit of their COO but essentially the portfolio managers control their risk.' ‘And you, as a pension fund, do not have a risk officer overseeing the total portfolio?' asked the regulator. ‘Not really. We have a strategic benchmark and invest according to that, and we are helped by our consultant in monitoring the portfolios'.

‘In Brussels we want to improve risk control and will have dedicated people responsible for total risk.' ‘How will you define risk? Will it be possible for these risk control officers to limit the allocations made by our selected managers after the event?' ‘Yes, after last year we have no choice.' ‘But that means investment managers will be managing to an investment benchmark as well as to the whims of a risk control officer. Well-meaning ex-post risk minimisation measures will affect anticipated portfolio performance.' ‘Yes, and all for the better if the risk can be minimised. Diversification is sometimes not sensible. Everything has been far too correlated.'

‘But ….' My host interrupted. ‘You see Pieter, there is much talk about safeguarding assets and a need to find a risk management solution which acknowledges that risk is not just standard deviation.' ‘It is liquidity risk, extremes in market volatility and environments where correlations between betas change dramatically from the norm.'

‘But where will the balance be? Is there not a danger of over regulation and too much control so that portfolio managers cannot take full advantage of market opportunities?' ‘Not at al. We would just be acting on an enhanced VaR model and we would be lowering our risk levels where we perceive it to be sensible.'

The regulator, smiling, asked why I was not convinced. ‘Pension plans are desperately underfunded. Staff need to be able to invest in a combination of strategies that offer the best chance for significant alpha generation at the lowest levels of anticipated risk.' ‘But that is what we want them to do to, but we will also help them to control that risk, and this of course has not happened to date.' ‘But pension funds allocate across a wide spectrum of managers, each with their own mandate and risk profile. It would not be practical for a risk officer to attempt to reverse trades of a particular portfolio strategy on the basis of total portfolio risk. How would he choose where to implement change?' ‘Pieter, there is too much risk if we do nothing.'

Pieter Mullen is investment director at Wasserdicht Pension Funds