Managing Investment Risk in Defined Benefit Pension Funds

Abstract

This paper inquires into the forces that drive the practice of risk management at defined benefit (DB) pension funds in Germany, Netherlands, United Kingdom and the United States in the aftermath of the perfect pension storm. First, pension funds‘ risk management is grounded in the context of the development of modern risk management in the financial industry more general. Second, focusing solely on single-employer sponsored DB pension funds this research critically examines the impact of recent changes in the regulatory and accounting environment for pension funds and their sponsors thereby explicitly taking into account the specific governance context in which pension funds are situated. The aim of this research is, first, to provide a better understanding of the investment risk management of DB pension funds thereby contributing to the theory of financial decision-making. Second, by conducting this analysis on a cross-country basis, this research aims at contributing to the comparative analysis of pension funds. This paper argues that the risk-taking capacity is a central element of DB pension funds. The empirical results suggest that in general risk management has become much more sophisticated but that it is often driven more by regulatory and accounting issues than by the pension fund‘s specific risk profile. Furthermore, changes to the regulatory and accounting standards increasingly impede the risk-taking capacity of DB pension funds. This research draws on in-depth interviews with market participants within the pension fund industry and their advisers. Les dispositifs de retraite à prestations définies et la gestion du risque d'investissement Le présent document analyse les ressorts de la gestion des risques telle qu’elle est pratiquée par les dispositifs de retraite à prestations définies en Allemagne, aux États-Unis, aux Pays-Bas et au Royaume-Uni au lendemain de la violente tempête qui a ébranlé le secteur des retraites. Premièrement, cette gestion des risques s’ancre dans le contexte plus général de l’élaboration d’une gestion des risques moderne par le milieu de la finance. Deuxièmement, en s’attachant exclusivement aux dispositifs à prestations définies mono-employeurs, ce document examine d’un point de vue critique les répercussions des évolutions récentes du cadre réglementaire et comptable applicable aux régimes de retraite et à leurs promoteurs, prenant ainsi explicitement en compte les mécanismes de gouvernance spécifiques de ces régimes. L’objectif de cette étude est, dans un premier temps, de mieux appréhender la gestion du risque d’investissement par les dispositifs de retraite à prestations définies, et d’étayer ainsi la théorie de la décision financière. En s’intéressant à plusieurs pays, les auteurs de ce document entendent dans un deuxième temps contribuer à l’analyse comparative des régimes de retraite. Ils font ainsi valoir que la capacité de prendre des risques est fondamentale pour les dispositifs à prestations définies. Les résultats empiriques donnent à penser que de manière génér...

Responsible Investing of Pension Assets: Links between Framing and Practices for Evaluation

“…The move to accounting treatments Responsible Investing of Pension Assets that introduce new forms of volatility in earnings and balance sheet values (for example, the IFRS recent focus on fair value measurements) produces two important effects. First, this potentially encourages a move out of equity investments into immunized investment portfolios focused on fixed income investments (Franzen 2010). This movement out of equities suggests new opportunities for creative thought around the inclusion of ESG factors in fixed income portfolios.…”

Determinants of equity pension plan flows

“…While Andonov et al (2013) focus on different types of pension plans (public, corporate and others), Franzen (2010) focuses on examining the investment risk management of defined benefit occupational and state pension plans in Germany, the Netherlands, the United Kingdom and the United States, concluding that changes in accounting rules based on the implementation of fair value criteria erode the risk-taking capacity of the plan sponsor. Brown et al (2012) analyze the investment behavior of US defined benefit state pension plans that actively manage their equity portfolios implementing ordinary least square (OLS) regression.…”

It's About Time! The Influence of Institutional Investment Horizon on Corporate Social Responsibility

“…The move to accounting treatments introduces new forms of volatility in earnings and balance sheet values. For example, the IFRS recent focus on fair value measurements has been adapted for public plans with recent changes by the Governmental Accounting Standards Board (GASB), 4 creating additional incentives to shorten the time horizon of investment portfolios (see Franzen, 2010 , for a discussion of accounting regulations and investment focus for pension plans). We expect, then, that pension funds, in contrast to acting as a single cohort in their interest in, or influence on, CSR objectives will exhibit difference according to their behavior as either long-term or shortterm investors.…”

“…Despite having a theoretically long-term investment horizon due to the long-term nature of their liabilities, PPS may still behave like transient investors. The presence of short-term monitoring cycles for accounting regulations (Franzen, 2010 ), and the hiring and termination processes for external investment managers (Cox, et al, 2008 ) may shorten the investing strategies of PPS. As our findings suggest, it is the presence of PPS that behave and invest as long-term, patient capital that positively influences the CSR activities of the firms in which they invest.…”