EDHEC Survey of the Asset and Liability Management Practices of European Pension Funds

This survey has been taken as part of the second year of the AXA Investment Managers “Regulation and Institutional Investment” research chair at EDHEC-Risk Institute. The objective of this research chair is to increase institutional investors' awareness not only of the challenges posed to financial management by regulatory developments but also of research advances in asset management and asset/liability management (ALM) that enable them to meet these new regulatory challenges.

The results of this pan-European survey suggest that, despite the professionalisation of ALM in pension funds and their service providers, risk-controlled strategies may not have been taken up widely enough. That these strategies are understood by only half of respondents may account, in part, for the lack of widespread adoption.

The recent underfunding of sophisticated pension funds suggests that there are biases that prevent many pension funds from managing their assets optimally. In theory, rule-based risk-controlled investing and discretionary economic capital should lead to the same insurance of risks. One of the theoretical drawbacks of economic capital is that it is a myopic strategy. A practical drawback is that the reliance on discretionary investment policies involves the risk of delays and of behavioural biases that distort the theoretical strategy (pension funds may be reluctant to sell at a loss, even though they rely essentially on market values and should, in theory, pay no attention to book values). In general, because rule-based strategies are compatible with economic capital and prudential risk-based regulations, we recommend more reliance on these strategies. Very simple and intuitive methods that require little or no mathematical background can prove to be efficient means of insuring risks.

The survey also suggests that pension funds have a blinkered vision of risks; only a minority, for instance, manage accounting risk and sponsor risk. The reluctance to manage their risks exhaustively can be seen as increasing risk to no purpose and may also lead to inappropriate volatility in the sponsor’s books.

The survey suggests, finally, that pension funds make insufficient efforts to measure the performance of their portfolios and to assess the suitability of the design of their strategies.