“Risk is always there but seldom clear, “ Urwin said. Some tests of risk – and Watson Wyatt recommends funds use several – are difficult to measure. “Not everything that counts can be counted,” Urwin said. It is easier to think about returns than risk. Risk frameworks are difficult to understand and the models on which they are based are not easy to play around with.
People tend to focus on what is most urgent or what is easier than what might be the most important. Martin Goss, Watson Wyatt’s head of client consulting, said that funds should look at risk and return together, combined with a number of risk measures. Watson Wyatt last year launched what it called a ‘Dashboard’ to assist funds in their assessments and decision-making processes around risks and return. Currently a tailored system for funds, the firm is currently looking to turn Dashboard into a more generic product for all funds.
Goss said that one of the areas of Dashboard which has been most appreciated by funds is the way it enables a risk management framework to be presented. He said that two of the characteristics of the global financial crisis with respect to pension funds were: the intensification of effort by trustees and fund staff, where governance budgets have been largely found lacking; and the necessity of having a risk management framework.
Urwin said after the conference that Watson Wyatt had been supportive of clients who had decided to not yet rebalance
their portfolios. This was quite controversial, he said. But Watson Wyatt was not publicly predicting how long the financial crisis would last. Instead the firm worked through a variety of scenarios but did not necessarily put probability numbers to each.
“Several scenarios are plausible,” Urwin said. “It’s implausible that over 2009 things will right themselves. If things go really well then it’s plausible it could be over in 2010. If you put a gun to my head I would be prepared to say that the most likely scenario is that it will go past 2010.” Carl Hess, the New York-based head of investment consulting, said that,
with hindsight, many market participants should have been able to see the warning signs of the crisis: “why did we ignore so many red flags?”
The crisis was a ‘black swan’ event – referring to Wassim Taleb’s book of the same name – whereby people underestimated the role of a high-impact random event in determining history. “The future can be different in ways that we can’t possibly imagine,” Hess said. “But it is possible to conceive outcomes if you work at it. You need to invest the time and effort in risk management.”