SWITZERLAND - The pension fund world lacks risk management and should look at structured products, an investment conference in Geneva has been told.
Koray Simsek, a professor of finance at the Edhec business school, advocated pension funds gaining exposure to guaranteed structured products.
Such products, Simsek said, offer a guarantee on the capital initially invested. “I am in favour of using them. These are called third-generation portfolio insurance products so they are a bit more sophisticated,” he told IPE on the sidelines.
“They would be very desirable especially to underfunded pension products.”
Senior Watson Wyatt consultant Edouard Stucki agreed that they may be useful to underfunded pension funds, which have decreased their exposure to equities.
But healthy funds would cut their downside risks, but in the process do away with the up-side risk. “When you are a fully funded fund, you may want up-side,” he observed.
Simsek and Stucki were speaking at a conference organised by Edhec.
Simsek explained that pension funds have two ways of implementing risk management: diversification and risk hedging, with guaranteed structured products in the latter category.
He argued they have risk-reduction properties and that once pension funds used these products, there would be no further need of risk diversification.
“They are natural investment vehicles for institutional investors keen on non linear pay-offs,” he told delegates.
Allocation to these products would depend on the pension fund’s risk aversion. He said for instance that investors with strong risk aversion would replace bonds with such structured products, while those keen on risk could avoid them all together.
But institutional investors should watch out for counterparty risk.
“As consultants we want providers with significant experience and legal teams who understand where pension funds are coming from, Stucki said.
He also mentioned the issue of costs, which had alienated some Swiss consultants to the product.
“Many colleagues do not like structured products,” he said - explaining that the consultant community does not justify the costs involved, which he said could be lowered through a higher degree of transparency.