Minyan Mailbag: Risk and Responsibility
Defining risk as volatility is convenient for academic purposes but may not work in practical applications.
Brother, you have no idea of the chicanery that masquerades as prudent advice.
I once worked for one of the largest (in terms of assets under advisory) pension consulting firms. So few people see things the way you and I do - that risk is in no way related to volatility of returns, but rather is related to loss of principal, loss of purchasing power, or - in the case of a pension fund - the risk of falling short of one's liabilities. Defining risk as volatility is convenient for academic purposes but it does not work in practical applications.
I would be hard pressed to tell you that we 'advised' clients. I say this because advice includes a discussion of risks as well as rewards. I'll leave you to guess which part was most often left out.
Scott Reamer would have a field day with the pension consulting industry. All of what he speaks of can be found there in spades.
Hopefully Minyans are getting an idea of such.
A pension fund manager should be a fiduciary responsible to the plan's holders (the employees). The primary responsibilities of the fund manager should be to understand the level and nature of its future liabilities and the variables that might affect them and then to match those liabilities with assets of commensurate risk and duration. Since the liabilities can be looked at as zero risk (the company will owe them for sure; or at least I used to think so), matching assets should have very little if any risk. This does mean a risk of potential loss of principal (more on that in a minute). Pensions used to own predominately bonds for just this reason.
Pension fund management used to be viewed as a cost center.
That was then and this is now. Pension fund management has become a profit center. When companies have needed earnings, a great many of them have turned to their pension plans for that money. This has put great pressure on fund managers to take more risk to make up the difference (companies take money by changing to unrealistic levels the assumption they will earn on those assets). Of course, with that increased risk comes a potential for loss, which a great many have incurred. Thus, the reach for risk has exacerbated the problem.
Your last point about using volatility as a measure of risk is correct. Volatility has only a loose association with the potential for loss of principal and can be viewed as an indicator of risk. It has been defined as risk by many Wall Street pundits because it can be measured (I have talked before about the linear nature of that measurement, which renders it almost useless) and controlled. But controlling volatility has a cost, so therefore it may not protect against loss of principal.
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