Optimal risk management of investments

In our role as asset managers, we compose and maintain investment portfolios for our clients in order to realise the desired risk-return profile. Our Front Office investment teams select the investments and are responsible for managing the investment risks. The Risk and Compliance teams independently supervise that 1) the risks in the investment portfolios are consistent with the desired risk-return profile and 2) they satisfy the preconditions stipulated by our clients.  

Financial risks

The financial risks of the investment portfolios are continuously measured, analysed, discussed with the investment teams, and compared to the predetermined risk limits and risk tolerances. The financial risks that PGGM Investments Risk & Compliance monitor can be divided into 1) market risks, 2) liquidity risks and 3) counterparty risks. In this context, market risk is deliberately incurred in order to achieve expected returns. All three risk types are reported on, both on the level of the individual investment portfolios (PGGM Investments funds and segregated mandates) and the client portfolio as a whole. 

During 2021, COVID-19 related market risks still got much attention. The health crisis and variations of the virus led to further restrictions, limiting economic growth and sound balance sheets. COVID-19 disruptions in the supply chain have resulted in delayed output and increased prices. From a credit risk perspective, a continuous focus was on our counterparties, as well as liquidity risks and volatility in client mandates.

Moreover, climate risk is an increasingly complex topic. In 2021, the energy demand was higher than the supply of (renewable) energy, causing high returns for the sector as well as high inflation globally. An initial framework was developed to integrate climate risks in the evaluation of investments. Several high emission companies were excluded from client mandates. Furthermore, the new Intergovernmental Panel on Climate Change (IPCC) report this year contained troubling conclusions regarding an accelerating increasing pace of global warming with (partly) irreversible damage to the environment. PGGM Investments has started to invest in more tooling to address this risk adequately. 

Also the regulatory environment had an impact on the PGGM Investments. For example the disintegration of PGGM Treasury B.V. last year resulted in large transfers of securities and cash balances to a new custodian and house bank. The introduction of the European Market Infrastructure Regulation (EMIR) and the Uncleared Margin Rules (UMR) meant a lot of preparation to post and receive collateral with counterparties.

Developments in China received extra attention. The Chinese Communist Party more strongly enforced control in the tech and the real estate sector, with several real estate firms (most notably Evergrande) on the brink of default. The risks appear to be contained for now, but potential impact on global markets and counter parties could be large. The Emerging Markets Credit mandate did not have any exposure to Evergrande or its competitors whereas the sector had a high weighting in the benchmark. The team has analysed the sector a couple of times (most recently in 2020) and always refrained from investing, due to the debt funded growth and opacity of accounting predominantly. This positioning helped the mandate outperform the benchmark significantly in 2021.

Higher inflation and higher interest rates are expected for the near future. It’s still an open question whether the inflation is transitory or persistent. Inflation leads to tapering (decreasing the quantitative easing by central banks) and may lead to a further increase of the interest rate. While beneficial for the coverage ratio, longer term interest rate increases may lead to a new risk: steerability. The risk of large rebalancing flows from equity to fixed income may result in a relative increase of illiquid assets on the balance sheets of our clients. Investments is developing tools to address this new steerability risk correctly.