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.
Highlights
Investing is an activity in which consumption today is foregone in an attempt to allow greater consumption at a later date
This paper looked at the policy issues arising from the trend to short-term investment behaviour by pension funds and life companies, lower equity holdings reflecting reduced willingness to take on risk, and pro-cyclical investing that exacerbates market cycles
This paper is not intended to be a comprehensive regulatory critique of the Solvency II standard formula Solvency Capital Requirement (‘SCR’) mark to market (‘MTM’), but is instead intended to be a broader consideration of risk measurement approaches across different businesses
Summary
Investing is an activity in which consumption today is foregone in an attempt to allow greater consumption at a later date. ‘Risk’ is the possibility that this objective won’t be attained. The Institute and Faculty of Actuaries’ Risk measures working party was initiated with the following Terms of Reference:. To inform discussion of the usefulness of alternative approaches to risk measurement for long-term liability constrained investments, with particular attention as to whether investment strategies might be skewed away from growth assets, to the detriment of long-term gain for customers and may increase their risk. To increase awareness of the possible influence exerted by the use of short term – viz. Banking based – risk assessment approaches and their impact on asset allocations in the real economy
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