Small plans may feel out of the loop when it comes to risk management, assuming they don’t have the resources to do it properly. But “increasing asset size isn’t necessarily related to improved risk management practices,” said Tom Lappalainen, director, strategic advice, Russell Investments Canada. He was speaking at the 2015 Risk Management Conference held in August in Muskoka, Ontario.
There is often a misunderstanding as to what true risk management is, he explained. In many circumstances, a peer relative focus, improperly applied concepts of risk and inadequate assessment of actual contributions to portfolio risk lead to ineffective decision making. The combination of peer group comparisons and behaviour-driven risk management decision-making can lead to “making exactly the wrong decision at exactly the wrong time.”
Best practices in risk management from larger plans include governance, alignment with enterprise risk, and having an ongoing total portfolio and risk management process. “The risk in a pension plan has to be reflective of the risk the enterprise can bear,” he said.
Larger plans do have some advantages, including access to diversifying asset classes (e.g., alternatives), diversification within asset classes and the ability to manage risk across a more complex portfolio. “The challenge arises if a smaller plan looks at these things and says, ‘There isn’t anything they can do at their scale’,” Lappalainen added.
When deciding how to approach risk, Lappalainen identified some fundamental questions that smaller plans need to address to move forward on risk management:
Smaller plans need to approach risk in a more focused and comprehensive manner, said Lappalainen, looking at enterprise risk management, incorporating surplus volatility, and using risk stress testing and scenario analysis.
Best practices for smaller plans include risk monitoring (know what you own); risk hedging strategy (know where you want to go); risk hedging execution (know how to get there); and risk reporting (know how you did). However, “there isn’t a single risk management solution to fit all smaller plans; each plan has different circumstances to determine which risks are most important to them,” Lappalainen added.
For a smaller plan that needs to revisit its risk management practices, he advises identifying the level of risk the enterprise can manage in dollar terms, knowing the risks to which the plan is exposed, identifying impediments to managing each of those risks, and reviewing how well their strategic partnerships help them actually manage risk.
“In doing this, risk should become something that is defined and managed more effectively,” stressed Lappalainen. Smaller plans do have a choice when it comes to improving risk management. The only real challenge, he concluded, is whether they elect to explore a different approach.