Investment risk for long-term investors: risk measurement approaches: Considerations for pension funds and insurers

Abstract

AbstractThe term ‘investment risk’ is often used loosely, and frequently confused with the notion of short-term price volatility, particularly for equity instruments. For the long-term investor, however, what is most apposite is the ability to meet future real cash flows as they become due. This paper addresses the concept of economic fundamentals of long-term investment, the objectives of long-term investors (and how these differ from those of short-term investors), the notion of real value shortfall risk, what is meant by an investor’s risk capacity (as opposed to risk appetite) and liquidity management considerations. Subsequently, some of the constraints and barriers to appropriate risk measurement and management are considered, in particular the regulatory and behavioural biases that are overlaid on fundamental asset/liability management. Various alternative approaches to measuring risk, and their appropriateness for purpose, are outlined, in the hope of further informing the discussion and thereby helping to accelerate productive change.