Straatman warns of volatility risk
EUROPE - Pension funds should now be looking to decrease their investment risk rather than introduce more because volatility risk is likely to rise, according to a former Dutch pension fund executive.
Jan Straatman, now chief investment officer at Axial Investment Management but formerly capital markets head at ABP, has suggested pension funds and institutional investors are at risk of increasing their liabilities rather than meeting asset return requirements because they are assuming volatility risk will remain low.
"Capital markets have been too friendly in recent years, equity markets have gone up, credit spreads have been very tight, people think the way things have been done over the last 30 years are still good enough and that is a problem," said Straatman.
"Looking at the correlations of assets can be risky because in 3-5 year [ALM study] projects, on 9 out of 10 occasions the distributions are increased and the liabilities do not match your output. Over the last couple of years, the volatility and risk has been coming down, suggesting you can now add more risk. But, inevitably, if risk premiums are coming down [risk] is actually increasing so we should now be reducing it," he added.
His latest comments come at the same time as some asset management houses are seeking to promote what they describe as volatility management - introducing additional volatility because they believe their pension fund strategies are already risk neutral.
But according to Straatman, who is now based in London at the asset management arm of UK insurance firm Pearl Group, European institutions and pension funds are already introducing return risks because most pension fund investment strategies are still based on asset liability modelling (ALM) studies which purport to offset correlation risk through asset allocation.
He suggests pension funds are still struggling to analyse their liabilities and how to manage their investment strategies because they are using ALM and portfolio studies which claim to be risk neutral but adopt either a quantitative or fundamental investment process.
"Liability modelling and asset modelling are continuous processes and we accept the fact liabilities are not stable over 3-5 years but are subject to continuous changes. We have organisations with good use of equity risk models in Europe. However, it is very difficult to aggregate fixed income with equities strategies under existing models," he added.
He moved to Axial last year and implemented a multiple assets, multiple layer investment strategy which he introduced at ABP in 2002 and which he suggests substantially reduces correlation risk.
While the firm at this stage largely manages internal insurance assets worth a total £30bn (€45bn), Axial has recently been touted as being interested in entering the pensions bulk buyout arena.