ABP was always going to be a hard act to trump and in its application for the IPE award it gave a comprehensive and impressive guide to its approach to risk management, the very foundation upon which investment is based. According to ABP’s Thijs Coenen, “the goal of our integrated risk management is to reduce the probability and impact of negative events and to increase the probability of positive events and their impact on achieving company objectives. By finding the perfect balance between company goals, risks and the level of management, integrated risk management is one of the decisive factors in the competitiveness of our company.”
In addition to managing credit and market risk, the focus at the Dutch fund has recently been on operational risk. ABP uses the definition laid down by the Basel Committee as being the risk of losses as a consequence of inadequate or lacking internal processes, people or systems, or because of external events. Coenen suggests, perfectly reasonably, that operational risk management must ultimately produce a greater level of certainty that a company’s objectives are met.
Since a hefty part of ABP’s submission to the awards focused on operational risk management, so it seems fair to elaborate a little. The fund tackles it by dividing it into six categories. Human resource risk is deemed to be the consequence of straightforward human error. Technology and systems risk emanate from the risks of imperfections in systems, the organisation of IT and the technological infrastructure. So-called processing and control risk is due to shortcomings in business processes while external environment risk is down to risks originating outside of the fund’s influence. Business strategy risk is a side effect of changing strategy and legal and regulatory risk arise from imperfections in both.
In terms of drawing up a strategy, the fund identifies the various risks, measures and evaluates them and then tries to come up with some means of controlling them. Having been identified, they are each evaluated to determine which are acceptable and which require additional control measures. To do so, the fund uses a raft of tools. Regular reports from both the front and back office are collected and quantified whenever possible and the fund also undertakes what it calls ‘risk dashboards’ which reveal deviations from the desired level of risk.
Operational risks that are unacceptable are naturally the most important to the fund and it therefore sets out a programme to try and control them. Every quarter ABP draws up a comprehensive report for the senior management and the risk management committee. ABP obviously measures and manages market and credit risk but there is insufficient space to elaborate on the means by which it tackles the two.
The reason so much attention is given here to risk management is because the findings are hugely relevant to the top down approach in which risk budgets are allocated and mandated. At the outset of the investment process, the strategic investment policy is set according to the risk profile of the pension fund. A number of strategic choices are made with an outlook of between three and five years. These are interpreted in the strategic benchmark (or the standard passive portfolio) and at the margins, or the so-called active risk budget within which the active management is executed.
Coenen says the strategic benchmark represents the neutral risk/return profile and stems from an ALM study in which the interdependence of investments and obligations is analysed. The most significant target variable is whether the pension fund is sufficient in the short and long term to fulfil the pension’s obligations. An important assumption is that both investments and obligations are measured according to their market value. The leeway available for active investment management at the fund level is also limited within an ALM context.
The investment strategy is formalised in a strategic investment plan and, depending on trends in the financial markets, on changes to policy and on internal and external developments that require a new ALM study, so is updated periodically. The investment plan is drafted annually, has an outlook of one year and includes the previous investment plan for the following calendar year. Based on forecasts of anticipated developments in the financial markets, the desired distribution between the types of assets, regions, countries and sectors is determined as well as the level of active management within each category.
In order to focus on short term developments, a monthly forecast is formulated by the Allocation Committee describing trends in the financial markets for the next three to six months. Based on these forecasts, the committee can decide whether to temporarily change the strategic allocation for the following month. Coenen says these TAA decisions are primarily related to asset and region allocation and the currency hedge allocation. These investment choices are crucial for the final profile of risk and return of the overall portfolio and the selected over and under weighting must remain within the risk budgets set forth in the investment strategy.

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