Early June’s Canada Cup of Investment Management conference in Canada’s financial centre of Toronto, and co-sponsored by Seeking Alpha, Goldman Sachs, Standard and Poors, PIMCO and Thomson Reuters, among others, was a roaring success. Roaring, that is, if you can imagine a room filled with 200+ pension managers and trustees, multi-billion dollar portfolio financial/investment advisors, and other assorted asset management executives. They were all there to lick their wounds and search for how best to weather the global economic slowdown and continuing volatile financial markets and how better to manage their portfolios’ returns and investment risk. There’s that four-letter word called ‘risk’ and it dominated the agenda at every turn.
The appetite for risk that was exhibited by institutional pension funds and conservative retail portfolios in 2008 has waned and the need for better asset liability management disciplines and liability driven investing solutions to manage risk has clearly taken centre stage and for good reason.
Black Swans and Red Returns
The largest 100 pension funds in Canada saw the perfect storm of 2001/2002 hit again with assets under management declining by 16.8% in 2008 vs. a gain of 3.8% in 2007. Only 6 funds saw their assets increase (by an average of 9.4%) or remain constant while 10 funds experienced declines in excess of 25% including one fund down over 30%. Bad as these performances were, however, Canada’s 16.8% average decline was still marginally better than the estimated 18% decline in global pension funds according to data from London’s International Financial Services ‘Pension Markets 2009’ report.
Most consultants and plan sponsors had been confident that the risk management strategies they had in place would help protect investors from any rough market conditions that came their way. As they soon learned the hard way, that was definitely not the case. Unfortunately, if the recent performance results are any indication, a full 94% had grossly underestimated the probability of severely adverse events in their risk models and strategies and are still reeling from the ramifications of that oversight. Indeed, were their returns to return to the average level achieved in 2007, it would take them 5 full years just to recoup their losses.
Some Funds Risk Insolvency
According to Alyssa Hodder, editor of Benefits Canada magazine, given today’s low-return environment, a significant number of these pension funds are, in fact, underfunded. In certain cases, she says, solvency funding relief may be available through extended payment schedules but that some say the provisions associated with such relief – particularly the need to get buy-in from members and retirees – make it unfeasible. If such is indeed the case, then it comes as no surprise that many employees are waving goodbye to thoughts of early retirement and wondering if they will have time to recoup their losses; that retirees are hammering on their former employer’s door seeking assurances that they will be paid their due; and that employers are worried about their ability to meet their pension obligations – obligations, states Hodder, that, for some, have the potential to sink the organization.
Inadequate Risk Management Models
It would appear, says Paul Forestell of Mercer, that everybody found out, much to their chagrin, that the risk management models that were being used – that the chance of such an event as the 2008 meltdown occurring was at one in 100 years - didn’t appreciate how bad the end effects could be. As such, he has concluded that new risk management techniques are desperately needed, along with timely implementation. Maybe it takes a crisis to make such issues a priority but will we learn from this experience or will we simply heave a collective sigh of relief that the worst is behind us and go back to business as usual?
From what I experienced as Seeking Alpha’s representative at the conference and from the sight of so many participants sitting on the edge of their chairs in rapt attention to what was being said at the sessions, however, is that the much needed lessons have been learned. I was left with the distinct impression that detailed de-risking reviews will soon be undertaken and that new models using skillful combinations of risk transference, risk sharing and risk mitigation will be quickly enacted to lessen the future impact of volatility in global capital markets.
There are those four-letters words being used again and again. Everyone at the conference left in agreement that coming to terms with the four-letter word called ‘risk’ was much better than the continued use of the many other four-letter words they had used during the past year to ineffectively deal with the decline of their portfolios. Yes, ‘risk’ is still a four-letter word but, for all of us, if it is properly understood and managed the reward side of the equation can be just that – rewarding.