Twin-track approach delivers performance and matches liabilities
ATP is no stranger to the IPE Awards and its victory in the silver best public fund category this year is further confirmation of its finely-tuned governance framework and inspired investment philosophy. With well over 4m active and deferred members, ATP is by far Denmark's largest. But it doesn't only have the active members to worry about. There are also 600,000 pensioners that depend on the scheme for the retirement income and benefits. ATP's approach is simple: understanding each element of the scheme is mutually dependent on the others and ensuring they come together smoothly and efficiently. ATP says this essentially means balancing the scheme's objectives with its investment strategy and risk budgets.
In line with liability matching laws that came into force in recent years in Denmark, ATP has reviewed its approach and has streamlined its portfolios. Since liability matching obliges schemes to value their liabilities against bonds, ATP has decided to separate its investment portfolio into two. One covers regular investments in conventional and alternative asset classes and the other is a ‘hedging' portfolio that contains the investments and processes that hedge the scheme's liabilities against interest and inflation risk.
The conventional portfolio is not so straightforward either, and is further separated into sub-portfolios for alpha generating investments and beta generating investments. The beta portfolio relies on looking at ways to increase returns by tracking indices and general market trends that affect the performance of the indices. ATP says this portfolio is highly diversified according to sector and geography, and uses risk efficiently and to the full.
The alpha portfolio, by contrast, seeks to produce excess or absolute returns from a more actively managed approach that bears no relation to the benchmarks driving its beta counterpart. Not only are the portfolios distinct but so are the management teams that run them. ATP says this level segregation fits perfectly with its corporate profile to maintain a highly organised scheme with clear objectives and personnel to meet them. This adds to the governance of the scheme and introduces greater levels of both transparency and accountability.
Incorporating absolute return investments means ATP has had to review its risk control philosophy. The use of derivatives has also changed the way the scheme approaches risk, as they allow for no common denominator.
Risk tolerance and budgets are determined by the scheme's board. The board considers the impact of a loss of major capital on the fund as a first step in setting the risk budget. Time is a factor and a set time period forms part of the analysis. Next it employs a programme of stress testing. This is based on the asset liability study which ATP says is under constant review. It was last amended last year to reflect changes to the investment classes making up its portfolios.
With over 500 lines under daily supervision, ATP's risk budget is huge and also now covers counterparty risk that arises form its use of derivatives in its hedging portfolio as part of its liability matching programme. The counterparty risks have clearly defined set limits.
At corporate level, ATP has also undergone change. The asset management, actuarial department and analysts were brought under common leadership in 2005, the scheme says. But different departments operating in the investment space remain autonomous to each other. ATP says this allows them to focus on their area of expertise and manage the risk budget the board affords them. In essence, there are risk budgets covering exposure to different asset classes and more specific areas like interest rate risk.
ATP says the teams managing the risk have different objectives and corporate role to play. This implies rigid monitoring of operational risk. Add to that the fact the scheme has been running a dynamic asset allocation policy since 2003, which clearly links investments with its liabilities and reserves, ATP adds it is crucial that its risk philosophy is based on core principles. This means risk budgets must be respected at all times. It also demands that its booking system for trades is updated each day and trade prices must be taken constantly, as the risk budgets are monitored and reviewed daily.
ATP firmly believes risk can only effectively be managed if it is fully-integrated and remains consistent. Integrating the risk means applying it to everything that appears on the balance sheets. Consistency is the result of applying the same processes of risk measurement for both ATP's liabilities and its investment portfolios.