Dynamic Management of Portfolio Risk

Date: November, 2019

Authors: Mads Gosvig (ATP), Morten Tolver Kronborg (ATP) and Ninna Reitzel Heegaard (ATP)

Abstract: 

In ATP, an old age supplementary pension scheme, pension benefits are guaranteed nominal annuities. The ultimate goal of ATP’s investment portfolio is to achieve a return high enough to increase the nominal pension benefits. High returns on the investment portfolio translates into increases of the guaranteed annuities through profit sharing (pension bonus) so that the value of pension benefits in real terms can be maintained. Achieving high returns is subject to keeping net assets above a certain threshold. This is managed through a probability-based risk tolerance mechanism to control the overall risk. The risk tolerance is set by the board of directors and cover multiple types of risks where market risk related to investments and longevity risk related to the pension provisions are the dominant types. The risk tolerance translates into a risk cap for market risk in the investment portfolio which depends on prior returns and thus gives rise to a requirement for dynamic management of portfolio risk. Within this framework, the two main questions are how much market risk is needed to achieve our investment return goal and how to implement a dynamic management of market risk to stay within ATP’s risk tolerance. This paper outlines our pension driven investment framework: the separation of liability hedging of the guaranteed pension benefits and the investment portfolio; the top-down management of risk; and the formation of a dynamic market risk target for the investment portfolio based on quantitative analyses and qualitative judgement. We conclude that our way of managing and taking on market risk balances being prudent and achieving our investment goals at the same time.