Understanding Risk in Pension Plan Investing

Implications: Financial analysts should always worry about the investments that pension funds make.  The above referenced article about hedge fund exposure is a good example.  However risk analysis of pension funds is too often limited to asset quality.  This is a big mistake. In analyzing pension funds, the source and use of funds must be appreciated.

Analysis: A pension fund is a financial intermediary.  Too often financial analysts focus only on the quality, and pricing, of the investment.  However as a financial intermediary, pension funds also must manage asset-liability risk.  The pension liability to employees/retirees has a duration (although challenging to estimate).  Risk management in pension funds must address both the 1) quality of the investment and 2) duration of the source of the funds used to finance the investment.

Financial analysts should be sensitive to both risk dimensions.