Analysts Stress Critical Need for Risk Management
Kristof, Kathy, THE JOURNAL RECORD
Pension plan managers are getting decidedly more cautious. And some say that's a signal that it's time for individuals to get cautious too.
Major pension funds are emphasizing "risk management" over high returns, according to a recent survey by Callan Associates Inc., a San Francisco-based consulting firm. The bulk of pension managers surveyed were going to greater lengths to diversify and to hedge their bets through complicated option techniques, says Gregory C. Allen, senior vice president of Callan's quantitative consulting group.
Risk management limits investment profits, but it also allows pension managers to cut their losses when the market goes against them. It's a technique that becomes popular when investment professionals believe the appreciation potential of their investments is limited, while the risk of losing a great deal in a market drop is great. That's a picture-perfect description of today's stock and bond markets, investment professionals say.
Why? Interest rates and inflation rates are at historic lows. When interest rates and inflation are declining _ as they have for the past couple years _ it's generally good for the economy, good for stock prices and excellent for the prices of previously issued bonds. That's one of the reasons that both stock and bond markets have posted stellar returns.
But now there's little chance that either inflation or interest rates will drop any farther. Indeed, many believe they'll rise _ at least modestly _ within the next year or two.
An interest rate hike would depress the prices of previously issued bonds, while a boost in inflation could dampen stock prices.
Additionally, there's risk of a "correction" _ marketspeak for a big drop _ in the stock market because prices, as measured by the Dow Jones industrial average, are bouncing around their all-time highs both in real numbers and in terms of key market measurements such as price-earnings ratios and dividend yields.
"There's been a specter of market adjustment on the horizon since last year," said Allen. "So you see a lot of pension managers looking to hedge away some of the risk in equity investing."
Individuals should take the pension manager's shift as a cue to rethink their own investing, too, said Esther M. Berger, first vice president of Paine Webber in Beverly Hills and author of a book called "Money Smart."
"Risk management is critically important right now," said Berger.
Unfortunately, Berger and other experts maintain that the key risk management technique _ diversification _ is being shunned by many individual investors. Too many individuals are going from 100 percent investments in certificates of deposit to 100 percent investments in stock mutual funds, they note. Some, perceiving the risks in the market, may now be shifting back into CDs, experts note. …