Managing for a total outcome rather than focusing on the returns of individual strategies or asset classes is the key to solving the risk/reward dilemma faced by many underfunded pension funds, according to State Street Global Advisors.
In a recent paper, “Managing Pension Risk: Confront Your Risk/Reward Dilemma,” the company offered insights for pension managers and investment committees and boards on how to manage pension risk.
State Street notes that investors’ ability to recognize and manage risk has been tested in the face of market volatility and a shifting regulatory landscape. New accounting rules that have emphasized greater transparency, the Pension Protection Act of 2006, which put more emphasis on the asset/liability mismatch, and increased capital market risk have caused pension managers to struggle with remaining properly funded, match assets to liabilities, and manage contribution increases.
“The environment that we’ve been in recently has presented increased challenges for pension managers and as a result, we believe there has to be an even greater emphasis on understanding risks across the portfolio and then managing those risks dynamically over time,” said Dan Farley, senior managing director of SSgA and chief investment officer of SSgA’s Investment Solutions Group. “We are working with plan sponsors to first understand the total portfolio situation, and help structure distinct growth and hedging portfolios to address the plan’s risk/return parameters.”
To successfully manage pension risk, there needs to be a clear understanding of an institution’s pension liabilities and where a plan may be at risk. There also needs to be a focus on the outcome; shifting from making strategy and asset allocation decisions based on asset return only, balancing the need for return with managing specific risk factors and devising unique portfolio designs tailored to each plan’s situation.
State Street Global Advisors is a global leader in asset management.