Managing Investment Risk

UTAM’s comprehensive risk framework takes into account a broad spectrum of potential investment risks, from counterparty concentration and liquidity needs to ESG factors, including climate change. The dedicated team of risk management professionals led by our Chief Risk Officer weighs all formal constraints, as well as our commitment to responsible investing, in ensuring that investment decisions reflect the University of Toronto’s risk appetite and long-term risk expectations for its Pension and Endowment assets.

Risk in the Pension and Endowment portfolios is determined by the asset class mix composition of the Reference Portfolio, along with any incremental risk arising from decisions made by UTAM or the managers that we invest with. Our investment risk management framework is anchored by three components focusing on market risks (including active risk), concentration risks (including credit and counterparty) and liquidity risks. Our risk management framework outlines the specific risk levels that UTAM operates within for each of these risk categories. Several of the risk limits, such as those in the active risk budget, are approved by one or more stakeholder groups, such as the university administration, the Investment Committee and the Pension Committee. These risk limits are embedded within our processes to ensure that any incremental risks are taken thoughtfully and efficiently. To that end, we manage the risk of the Pension and Endowment portfolios so that it is consistent with the university’s specified active risk budget, and we incorporate several additional limits on asset class exposures, concentration and liquidity.

A Comprehensive Risk Management Process

Market Risks

UTAM identifies, measures and monitors a variety of market risks on a point-in-time basis and on a trend basis (i.e., over time) using a third-party holdings-based risk system. We begin by loading all available investment holdings from our managers into the system. Where positions are not available, we use a variety of techniques to incorporate relevant risk exposures. For private investments, we develop multi-factor proxies that reflect the key risk drivers of the positions.

Once we’ve populated the risk system with actual holdings and proxies, we measure active risk (i.e., actual portfolio risk minus Reference Portfolio risk), and we identify specific active risk contributors by asset class, investment strategy and investment manager. We monitor the exposures of the Pension and Endowment portfolios to different sectors, geographical regions and credit-rating categories. For the short-term working capital portfolio (EFIP), we apply other risk monitoring and measurement techniques appropriate to those holdings. We also assess the highest risk concentrations among individual issuers across the entire portfolio and within each asset class. We estimate the sensitivity of the portfolio to potential changes in market risk factors such as equity market shocks, shifts in interest rates and credit spreads, and adverse movements in foreign exchange rates. These analytics are all integrated through a simulation analysis to assess the possible portfolio impacts and sensitivities to different capital market regimes and scenarios, including a severe global market downturn.

In 2018, we further enhanced our analysis to include asset liability modelling for the Pension portfolio using a dynamic scenario generator, which allows us to analyze the behaviour of the investment portfolios and the liabilities across a number of different plausible forward-looking path-wise scenarios. Our analysis provides insights into overall risk exposures and identifies specific markets, factors and regimes to which the investment portfolios are most vulnerable. The output of this analysis is discussed at regular meetings of our Management Investment Risk Committee and informs our decision-making on how these risks should be managed going forward.

We compare the various risk measures calculated for the Pension and Endowment portfolios against the same risk measures for the Reference Portfolio, and we model all three portfolios at the individual security level. We conduct this process monthly with updated holdings, gaining a detailed picture of active risk across the portfolios over time. Through constant measurement and monitoring, we’re able to better manage risk associated with specific investment decisions on both a relative basis and an absolute basis, which enables us to make well-informed investment decisions.

Active Risk Limits

Active risk is defined as the risk (i.e., volatility) in each of the Pension and Endowment portfolios minus the risk in the Reference Portfolio. The amount of active risk permitted in the Pension and Endowment portfolios is shown in the “traffic light” table below. For example, the “green zone,” which is an acceptable range of active risk requiring no action, extends from taking 0.50% less risk than the Reference Portfolio to 1.50% more risk than the Reference Portfolio. We measure active risk on a monthly basis.

The active risk budget and the other risk constraints that have been set by the university and other stakeholders are at levels that are viewed as being large enough to permit UTAM the flexibility to achieve its value-added objective but not so large as to put the Pension and Endowment assets at undue risk of loss relative to the performance of the Reference Portfolio.

Active Risk ZoneActive Risk
Green (“Normal”)-0.50% ≤ Active Risk ≤ 1.50%
Orange (“Watch”)1.50% < Active Risk ≤ 1.75%
Red (“Reduce”)Active Risk > 1.75%

Working alongside the UTAM team, we provide the risk systems and data management tools they need to evaluate risk and exposures across multiple asset classes, as well as the total portfolio – and together we’ve developed custom analytics to gauge risk from many different perspectives. UTAM continually challenges us to take the analysis even deeper as we deliver the quality of insights that UTAM needs to manage the University of Toronto’s Pension and Endowment investments for the long term.

Zoubair Esseghaier, Head of Investment Analytics North America, State Street Global Exchange

Liquidity and Counterparty Risk

We’ve developed a process to model the potential liquidity needs of the Pension and Endowment portfolios under stressed market conditions. This helps ensure that adequate cash and other sources of liquidity are available to meet all liquidity needs over an extended period. The same modelling analysis ensures that we can, if necessary, rebalance the Pension and Endowment portfolios to match the target asset class weights of the Reference Portfolio.

The Pension and Endowment portfolios have credit exposures to individual counterparties through security holdings in the equity and bond markets. We also generate credit exposure through our use of derivatives used to hedge currency exposure and through cash deposits with financial institutions. We establish fixed limits for individual counterparties that we monitor regularly. These limits ensure that the portfolios are not overexposed to negative shocks from any single counterparty.

Deeper Analytical Insight

The Investment Committee and the university administration view these active risk, liquidity and counterparty limits as sufficient to give UTAM the flexibility to achieve our value-added objectives – but not so large that they put the portfolios at undue risk of significant underperformance relative to the Reference Portfolio.

From our perspective, highly disciplined risk management is critical. But it’s just one facet of a mandate that’s defined by a range of commitments and constraints, from the balance of equities and fixed income in the Reference Portfolio to UTAM’s adoption of responsible investing principles. Indeed, as detailed in our Responsible Investing Reports, we now consider ESG risks systematically in our evaluation of investment managers. Through a mix of analytics, research and consultation, we’re able to gain a better understanding of ESG risks across our portfolios.

In every area of risk assessment, as we analyze data on underlying positions and historical returns, we gain deeper insights into our investment managers. It’s a constant learning process that starts right from the initial due diligence component of our manager selection process and continues throughout our investment relationship.

Management Investment Risk Committee

Overseeing all of our investment risk activities is the Management Investment Risk Committee (MIRC), chaired by our Chief Risk Officer. This committee is also responsible for developing investment risk policies, reviewing risk reports, reviewing client portfolio investment risk positions and addressing all investment-related risk issues.

The MIRC is composed of staff on the Risk and Research team, the CIO and other senior investment staff, and typically meets quarterly or more frequently as necessary.