How global events hit your pension fund

But the recent equity sell-off and the spike in equity volatility are sharp reminders to pension schemes not to ignore geopolitical risk. They have been urged by market experts to take the necessary steps to build protection into their portfolio design.

It is not that easy to build geopolitical robustness into a portfolio. Remi Ajewole, multi-asset fund manager at Schroders, says: “These risks stem from human behaviour and it’s inherently difficult to predict how politicians will react.”

He adds: “The best strategy is for pension funds to focus on those asset classes that will enable them to achieve their long-term objective.”

In the past, given the unpredictability of geopolitical risk, many schemes might have assumed the best course was simply to diversify across multiple asset classes. But this can be an overly simplistic solution.

When there is geopolitical risk, those asset classes which are the most expensive are the most vulnerable as these are the assets that investors are most likely to sell first

Remi Ajewole, Schroders

Gurjit Dehl, senior vice president at investment consultancy Redington, says: “Pension schemes need to ask the question: ‘What are they diversifying?’ Is it just the assets or is it a wider diversification of the whole portfolio?”

Another way to think about diversification is to look at the drivers of risk as well as those of return.

“That means taking a closer look not only at the risks in the asset side of the portfolio but also the liabilities, and ensuring the scheme is not taking on any risk which is not rewarded,” says Dehl.

Valuation is also important. Ajewole says: “When there is geopolitical risk, those asset classes which are the most expensive are the most vulnerable as these are the assets that investors are most likely to sell first.”

Pension schemes should seek out those portfolio managers who take the time to understand how risk factors will affect their funds. That can require detailed scenario analysis to understand which factors will be impacted by a particular event and how the asset correlations might be altered.

Kevin Kearns, senior derivatives strategist at investment manager Loomis, Sayles & Company, says: “We look back at history to see what happened when a particular geopolitical event occurred, look at the impact that event had and project that onto our current portfolio.”

Once that analysis has been carried out, a picture emerges of which assets would be impacted and how much of a loss the portfolio could suffer if that event were to occur.

“We can then look at whether there are option strategies or deep hedges [that] could be put in place to provide protection,” says Kearns.

Pension schemes can today take a sophisticated approach to ensuring their portfolio is protected from geopolitical risk.

A close look at the liabilities and the aims of the fund is often the starting point, while pension funds could seek out those managers who stress-test their portfolios.