GLOBAL - A set of good practice standards relating to the risk management of alternative investments by pension funds has been developed by the International Organisation of Pension Supervisors (IOPS).
It said supervisory authorities recognised that, in principle, there was a place for alternative investments within pension funds because they could provide the opportunity to better manage or lower overall portfolio risk by proper diversification of assets, and allow pension funds, as long term investors, to benefit from the liquidity premium that may be associated with less liquid instruments.
But it warned: "Pension fund supervisory authorities recognise that riskier strategies are often inherent in alternative investments, given they were initially designed for high-net worth individuals - with a consequent high risk tolerance.
"Such investments may be complex, illiquid or opaque, and therefore require careful scrutiny and analysis, and in many cases, more rigorous review and monitoring than most traditional products - particularly when potentially vulnerable investors, such as pension fund beneficiaries, are involved. Fiduciaries should therefore very carefully consider the risks to which they are exposing their members' funds."
Alternative investments covered by the standards included hedge funds, private equity and securitised real estate investments.
The standards cover characteristics of alternative investments; portfolio and investment strategy; due diligence; contract terms and monitoring; communication and outsourcing.
They warned that where outsourcing was used, the pension fund remained responsibile for, and should ensure, adequate risk management for alternative investments.
It also said supervisory authorities expected pension funds to check at regular intervals that diversification across investment strategies was adequate and that undesirable concentrations in the portfolio were avoided.
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