Institutional Investment Report Finds Investors Want Better Risk Management

The big news coming out of Tuesday’s release of The Conference Board Governance Center’s 2009 Institutional Investment Report: Trends in Asset Allocation and Portfolio Composition was that all major categories of institutional investors have remained fundamentally committed to the same investment policies they adopted prior to the credit crunch. But a key finding under a section on hedge funds and alternative instruments may be prescient for the coming year: investors demand stronger risk management and transparency.

2009 Institutional Investment Report

As large asset managers were faced with the prospect of dwindling returns in the mainstream equity and bond markets, many turned to alternative investments like hedge funds, according to the report. Additionally, asset managers cited a need to diversify their portfolio and a growing familiarity with such investments.

In a year that saw the largest 200 defined benefit plans total assets decrease substantially to $4.71 trillion in 2008 from $5.60 trillion in 2007, those same plans increased hedge fund investments to $80.6 billion, or 1.7 percent of total assets, from $76.3 billion, or 1.4 percent of total assets, the report says. That section of the report makes a point to state “industry underperformance, coupled with some highly publicized hedge fund debacles, have prompted many boards of trustees to call for more stringent oversight of allocation decisions as well as rigorous due-diligence standards for the screening and selection of alternative investment vehicles.”

The report, which was co-authored by Matteo Tonello, associate director of corporate governance research at The Conference Board, and Stephan Rabimov, economist at the World Lung Foundation as part of the Bloomberg Global Initiative to Reduce Tobacco Use, goes on to state that boards are also calling for robust risk management programs and adherence to additional voluntary reporting.

That’s not to say hedge funds are the only investments that need better oversight. There’s enough blame to go around throughout the whole investment community. That is why organizations like the Investment Company Institute (ICI) is beating the drum for real risk management now. Case in point was ICI President and CEO Paul Schott Stevens’ Sept. 24 speech at the ICI Capital Markets Conference in New York City.

“Clearly, we need to create structures that look across borders, across business lines, and across jurisdictional fiefdoms to anticipate and address serious threats to the stability of the financial system,” Schott said. “No existing regulator has the breadth of vision or detailed knowledge to cope with these complex and multi-faceted risks.” ICI has lobbied Congress to establish a Systemic Risk Council, which would include the SEC, FDIC, Treasury and the Federal Reserve. That council would be responsible for identifying risks and directing regulatory actions. That idea has the endorsement of SEC Chair Mary Schapiro and FDIC Chair Linda Bair, who is credited with coming up with the idea.

The need for risk management information and analytics as it pertains to the investment process is a top priority for institutional investors, according to a survey completed by Northern Trust in July. Ninety percent of respondents rated risk as an “important” or “primary” consideration in their investment decision making. Additionally, many believe they need more skills and experience to effectively model, interpret and utilize the results of sophisticated risk models.

The Conference Board’s Institutional Investment Report documents the presence of different types of institutional investors in single asset classes, such as equity, debt securities, alternative instruments (including hedge funds) and foreign securities. The 2009 edition includes definitive data for 2008 and discusses trends that have emerged in the most recent months.