Being clear about why a risk system is needed, and having a governance structure that is able to support its integration, are two key findings Cbus has taken from implementing a risk system across its asset classes.
Cbus’ risk system uses a modelling approach for market risk to examine changes in asset price movements, Ciaran McBride, general manager of investment performance and risk at Cbus, told delegates at the Fiduciary Investors Symposium.
McBride added that super funds needed to decide which problems needed solving before a risk system was put in place, and cautioned is was only part of a risk mitigation strategy.
“And be clear who the end users are. Is it the board? Is it the investment committee? Is it the CIO? Is it the portfolio manager? They will all have different requirements. And they may well look at risk in different ways.
“It sounds like a very basic question, but when you have multiple stakeholders across multiple asset classes, it can be a real challenge.”
For example, Cbus’ system gives information on the volatility of the portfolio, but it does not give any information on the starting point of the market. Therefore, it gives the same number whether valuations are high or if they are low.
“You may have a very different opinion of whether that risk is high or low for the same metric in different markets, so it’s around what other information you need to provide to help you make your investment decisions,” McBride said.
The second takeaway that McBride felt valuable for other super funds to know, was that a wider governance and risk framework must support the system.
“The primary aim of the risk system must be to influence investment decisions. It must give you insights. It must give you better more informed decisions. But, do you have the risk framework? Do you have the governance framework to allow you to integrate with this new system?”
For example, it is important for a super fund to have a separate risk appetite statement that goes into the level of detail of providing thresholds on metrics such as VAR, tracking error and volatility.
“The chances are that if you haven’t had one of these systems before, you haven’t detailed that in a risk appetite statement. And even if you have, what happens if you breach one of those thresholds?
“The risk system will only give you one lens into risk; it must be supported by a wider governance framework to fill in the gaps. And getting that right upfront will pay dividends.”
McBride said despite computers and financial maths-enhancing risk systems, no tool and no model will give the complete picture of risk all the time.
“The results aren’t foolproof and can be a long way from real world outcomes. They need to be used in a wider governance and risk framework. This supports the things the model can’t do.
“The real richness, the real benefits, the real insights that come from using a system, come from an integration of the discussion around the outcomes, not the results themselves.”
On the same panel as McBride was Joseph Clark, senior quantitative strategist at QIC, who said his organisation was very concerned about nonlinear risk.
“We have a concept which we call stress beta – the beta an asset will have in a stress environment. It’s possible to construct an options portfolio to hedge that specific beta in a stress environment,” Clark said.*
Meanwhile, Liza McDonald, responsible investment manager at First State Super, said the super fund had been investigating the risks posed by climate change to the portfolio. Because of this research, the super fund now has an adaptations plan that has three components.
The first component is a technical review of all the fund’s holdings over time to assess the level of climate change risk exposure and implementing options to increase resilience.
The second component is increasing engagement with companies so that they are better positioned to meet the challenges presented by climate change.
And the third component is looking for opportunities, such as potentially investing in renewable energy and related technologies.
*Quote updated on 12/05/16 to give greater clarity
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