To help meet Pension and Endowment’s risk and return objectives, the University and the Pension Committee have adopted a Reference Portfolio which provides a passive and easy to implement benchmark to evaluate both the risk that UTAM is taking in the Pension and Endowment portfolios as well as the performance of UTAM’s active management approach.
The risk in the Pension and Endowment investment portfolios reflects the combined effect of the Reference Portfolio’s asset class mix as well as any incremental risk that arises from the investment managers selected by UTAM. The Reference Portfolio is designed to provide an indication of the University and Pension's long-term risk appetite, and a specific active risk limit is given to UTAM to control how far UTAM can deviate from the risk in the Reference Portfolio. Once the Reference Portfolio and active risk limits are established, UTAM has discretion to make and implement investment decisions with the objective of achieving returns (after all fees and expenses) that exceed those of the Reference Portfolio, as long as the risk of each of the portfolios remains within the established risk limit and all other investment constraints are satisfied.
UTAM identifies, measures and monitors a variety of risks in the Pension and Endowment portfolios and the Reference Portfolio using a third party, holdings-based risk system. For all direct investments (e.g. bonds and stocks held directly by the Pension or Endowment), and to the extent possible for indirect investments (e.g. a pooled fund held by Pension or Endowment that itself holds bonds and stocks) security-level holdings (e.g. the specific bonds and stocks) of Pension and Endowment's managers are loaded into this risk system. Where public holdings are not available (e.g. for private investments) a public market proxy is developed that reflects the market risk exposures. The risk system, once populated with actual holdings and proxies, is able to measure total portfolio risk, active risk and contributions to risk from asset classes, strategies, and managers. Using the information from this risk system, UTAM is able to, among other things, monitor exposure to sectors, countries, and credit rating categories as well as monitor the highest concentrations to individual issuers in any security category. Sensitivities to changes in individual equity markets, interest rates, credit spreads, and foreign exchange rates can be estimated within this system. Moreover, we calculate the impact of severe market downturns on the Pension and Endowment portfolios using simulations within the risk system. As the Reference Portfolio is also modelled at the security level together with the Pension and Endowment portfolios, the University’s portfolios can be compared to the Reference Portfolio for all of the risk measures described above. This allows a detailed understanding of the active risk in each portfolio at a point in time, as well as over time, as this process is run monthly with updated holdings.
Risk measurement and monitoring helps us to manage risks arising from both our investment choices and from the market environment. Importantly, this detailed understanding of risk allows UTAM to thoughtfully allocate more risk to those managers that have the highest expected return for the amount of risk used. We believe this allows us to make better informed manager and portfolio allocation decisions. UTAM also models the liquidity demands that might be faced by the Pension and Endowment under stressed market conditions. We use this analysis to ensure that adequate cash and other sources of liquidity are available to meet all settlement requirements through an extended period of market stress. The same modelling allows UTAM to establish confidence in its ability to rebalance the Pension and Endowment portfolios back to Reference Portfolio target weights as required. The Pension and Endowment portfolios have credit exposures to individual counterparties through security holdings in the equity and bond markets, and through the derivative contracts used mainly to hedge foreign exchange exposures and to rebalance the Pension and Endowment portfolios back to the target asset class weights in the Reference Portfolio. UTAM establishes limits for individual counterparties that are monitored on an ongoing basis.
Taken together, the active risk, liquidity and counterparty limits are viewed by the University as being sufficiently large to permit UTAM the flexibility to achieve its value added objective, but not so large as to put the portfolios at undue risk of significant underperformance relative to the Reference Portfolio.