SunGard: Pension funds at risk – The new approach For Long-term investment
Posted: 6 January 2014
The pension fund industry is at an inflection point in its view of risk. The fear of under-funding in the face of falling returns and unfavorable demographics is leading to a greater investment in more exotic instruments such as derivatives and alternative assets. However, this is changing the risk profile to a point beyond what is normally captured through the core metrics and models employed by pension funds, creating a challenge to the traditional risk management approach.
How the pension fund industry is changing
The macro demographic challenge facing the pension industry is well known – an ageing population means that pension fund members are drawing from rather than adding to that pension fund, and therefore increasing its liabilities. The same underfunding pressures that have affected state pension plans are now being experienced by private pension plans.
The difficulty in funding the plan and providing capital protection through the current contributions is exacerbated by the fact that, following the financial crisis of 2008, the global economic environment is one of low growth and low inflation. And there are also capital market pressures. a series of market shocks over the last decade have severely affected fund valuations and the ability to create future cash flows based on the capital value.
This dual-pronged dilemma of trying to get higher yields from a lower base while maintaining growth in the fund is forcing pension funds to pursue more creative and arguably more aggressive investment strategies in order to meet their funding challenge. there is no shortage of options – indeed there is an almost bewildering array of new investment opportunities available to pension fund managers – derivatives overlays, increased exposure to alternative assets such as real estate and infrastructure, and the use of swaps as hedging tools. However, the pursuit of these strategies will have a fundamental impact on the risk management of the fund.