UK - Falling equity returns have forced companies and their schemes to focus on risk when making investment decisions, Watson Wyatt claims.
The consultant says it has seen a surge in the amount of risk budgeting work it conducts for clients due to “persistent” volatility in investment markets.
Watson Wyatt says it has completed 50 risk budgeting projects for clients this year. Risk budgets, which form the basis for all investment decisions, are drawn up and agreed by the plan sponsor, trustees and consultant.
Risk budgets help companies and trustees to determine how much risk the scheme poses to the sponsor, whether this is appropriate, where it should be spent and what level of returns they should expect. From there, they can make decisions about what asset classes to invest in and how much.
A lower risk budget improves the security of members’ benefits; however, a higher risk budget offers a higher potential for returns and correspondingly lower cash contributions.
Watson Wyatt partner Nick Horsfall said: “We anticipate plan sponsors getting increasingly involved in setting risk tolerances for their pension funds as they begin to appreciate their shared role in the spending of agreed risk budgets.
“It enables the company to quantify the potential balance sheet risk and then translate that into possible cash contribution requirements and funding levels.”
Watson Wyatt believes that focusing on risk when making investment decisions is appropriate because it is more accurate to predict future risk levels than it is to predict returns.
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