Operational, Political Factors Driving Risk Management Practices

A study by The Bank of New York says the emergence of new 360-degree view of risk will influence investment performance


A study by The Bank of New York says the emergence of new 360-degree view of risk will influence investment performance

New York — October 3, 2005 — Pension plans and non-profit organizations worldwide are significantly expanding the scope of their risk management practices by increasingly considering the operational and political risk factors that can impact fund performance and future obligations, according to a study released today by The Bank of New York in partnership with Wilshire Associates, ING Group, and Harry Markowitz, Ph. D., 1990 Nobel Prize winner in Economics.

The study, "New Frontiers of Risk: The 360 Degree Risk Manager for Pensions and Nonprofits," found that while market risk remains the foremost concern for plan sponsors, managers are now spending close to 40 percent of their risk-related time on operational and political considerations — an increase of nearly 20 percent from five years ago — and about 80 percent indicate they will increase the time spent on operational risk over the next five years.

The study identifies a new standard for risk managers — an all-encompassing, 360-degree view of risk — that will impact a firm's ability to achieve positive investment results.

According to the study, several factors are influencing this standard including:

  • Widespread under-funding of pension funds. Of the participants who provided funding status, more than half categorized their funds as "under-funded" across all types of pension plans.

  • Significant changes in plan allocations and strategies. In the last five years many study participants have introduced or increased allocations to non-traditional investments such as real estate, private equity, hedge funds, derivatives and commodities. More than one-third of the participants have invested more aggressively; two in five of these plans have done so simply to maintain returns, where target returns remain about 8% nominally on average.

  • Complexity of global markets and changing equity allocations. During the last five years, nearly 55 percent of study participants increased their allocation to non-domestic equities and 46 percent increased their allocation to emerging market equities.

  • Interconnection of political, legal and natural risks. Legal and regulatory changes, disaster recovery, and extreme or unanticipated events are substantial and growing.

"The study shows that investors increasingly recognize the non-traditional risk factors associated with the global investment landscape, namely operational and political risk. The challenge for all organizations will be embracing this new 360-degree view and taking the formal steps necessary for eliminating, transferring or managing critical risks," said Debra Baker, managing director and head of Global Risk Services for The Bank of New York.

Operational Risk: A Broad Risk Narrowly Understood

The two operational risks that most concern pension funds and non-profits are headline risk (exposure to negative press) and service-level risk (failure to achieve prescribed service goals). Plan sponsors felt the most essential elements in mitigating such risks were effective senior leadership, culture of integrity and financial reporting.

"The survey shows a growing appreciation for risk management," noted Robert Raab, Jr., vice chairman and senior managing director, Wilshire Associates, who heads up the Wilshire Analytics business unit. "While operational and political risk management are still in the early stages of evolution, plan sponsors and nonprofits look to third-party resources to measure, monitor and analyze these risks, just as they do when assessing market risk. Working together, plan sponsors and industry providers are developing advanced analytics and reporting required to quantify risk level and focus on interventions."

Political Risk: The Need for Reassessment

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