The Biggest Threats to a Pension Fund's Growth (w/ Jim Keohane)

TL;DR

Pension fund discusses using derivatives and absolute return strategies to effectively manage asset allocation and mitigate risks.

Transcript

ED HARRISON: Because you were talking about liability driven investing. And there were some other things that you talked about. I want to talk about what you are able to do that individuals aren't able to do. And in particular, I'm thinking about your asset allocation mix as well as some of the other things you were talking about. What, as you thin... Read More

Key Insights

• 😒 Pension funds can use derivatives as an overlay to gain equity exposure without selling existing bonds and creating interest rate mismatch.
• ↩️ Absolute return strategies, typically used in hedge funds, can help pension funds control risk and achieve desired returns.
• ✳️ By aligning assets and liabilities, pension funds can reduce major risks like equity market exposure and interest rate risk.
• 🚟 Effective asset allocation in pension funds involves finding a balance between risk reduction and desired returns.
• 🚟 Utilizing derivatives and absolute return strategies, pension funds can create a less risky portfolio structure compared to traditional approaches.
• 🚟 Pension funds can mitigate catastrophic impacts by diversifying their portfolio with absolute return strategies that have quantifiable risks.
• 🙃 Trade-offs in asset allocation can result in less volatility and downside risk while sacrificing some upside potential.

Questions & Answers

Q: How did the pension fund improve its asset allocation after the 2000 tech meltdown?

After experiencing a surplus turning into a deficit, the fund realized that the traditional 60-40 equity plan was too risky. They began using derivatives to align assets and liabilities, overlaying equity exposure on bonds to reduce interest rate mismatch risk.

Q: What are the two biggest risks for most pension funds?

The two biggest risks for pension funds are equity market exposure and interest rate risk. By using derivatives, pension funds can gain exposure to equities without selling bonds, reducing interest rate mismatch.

Q: How does the pension fund utilize absolute return strategies?

The pension fund includes a diversified portfolio of absolute return strategies, such as equity long shorts and credit long shorts. These strategies provide enough return to achieve desired levels of return while reducing equity market exposure to about 35%, compared to the industry average of 60-70%.

Q: What is the trade-off the pension fund makes in its asset allocation?

The pension fund intentionally makes a trade-off by reducing equity market exposure. While they may not perform as well during a big up year, they would lose significantly less during a big equity down market compared to their peers.

Summary & Key Takeaways

• Pension funds need to align their assets and liabilities to reduce major risks, such as equity market exposure and interest rate risk.

• Derivatives allow pension funds to break down their portfolio and manage risk more effectively by overlaying equity exposure on top of bond investments.

• Absolute return strategies, typically used in hedge funds, help pension funds control risk and achieve desired levels of return while reducing equity market exposure.