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FRM 2006-Pension risk
This week’s movie is published for subscribers: a 30-minute tutorialon pension fund risk (assigned readings V.4 and V.5). Please note: this is the final movie in the regular schedule. In two weeks, we will publish the "cram session" tutorial.
Armed with data that shows both relative and absolute volatility are more stable than relative and absolute returns, Bewickand Young argue that it is easier to manage risks than returns. Theytested six rebalancing strategies over a 14+ year time period. Four ofthe strategies are variations of risk rebalancing(i.e., the portfolio is rebalanced if/when standard deviation exceedssome threshold). All four risk rebalancing strategies were moreefficient (as measured by the Sharpe ratio; Sharpe = excess return /standard deviation) than both annual rebalancing and range rebalancing:
We review the three-step risk budgeting process…
…andthe four levels of risk. The idea is that, given a liability, thepension fund can potentially under-fund at four levels. First, strategic (or policy) allocation can under-fund the liability, (a very real problem for many pension funds, currently). Second, the tactical asset allocation (TAA) canunderperform the policy allocation. (TAA involves deliberate,short-term deviations from the policy aimed at exploiting temporaryopportunities). Third,tracking error is the risk that the active, plan-wide portfolio under-performs the TAA or benchmark. Fourth and finally, each manager has active risk against his/her assignment:
Armed with data that shows both relative and absolute volatility are more stable than relative and absolute returns, Bewickand Young argue that it is easier to manage risks than returns. Theytested six rebalancing strategies over a 14+ year time period. Four ofthe strategies are variations of risk rebalancing(i.e., the portfolio is rebalanced if/when standard deviation exceedssome threshold). All four risk rebalancing strategies were moreefficient (as measured by the Sharpe ratio; Sharpe = excess return /standard deviation) than both annual rebalancing and range rebalancing:
We review the three-step risk budgeting process…
…andthe four levels of risk. The idea is that, given a liability, thepension fund can potentially under-fund at four levels. First, strategic (or policy) allocation can under-fund the liability, (a very real problem for many pension funds, currently). Second, the tactical asset allocation (TAA) canunderperform the policy allocation. (TAA involves deliberate,short-term deviations from the policy aimed at exploiting temporaryopportunities). Third,tracking error is the risk that the active, plan-wide portfolio under-performs the TAA or benchmark. Fourth and finally, each manager has active risk against his/her assignment: