Taiwanese IIs responding to a risky world

Many are adopting tail-risk protection into their asset allocation strategies, but a conference hears how they are also seeking to diversify to counter high domestic inflation.

Natural disasters and political unrest worldwide combined with high domestic inflation have made risk management and principal protection the key concerns of institutional investors in Taiwan, a conference heard.

Janet Li, director of Investment Services (Taiwan) at consultancy Towers Watson, told AsianInvestor’s 5th Taiwan Institutional Investor Forum in Taipei that, post-crisis, investors have been adopting tail-risk protection into their asset allocation strategy.

“There are some events that people can’t foresee, such as the earthquake in Japan,” she said. “But knowing what we don’t know is different from not knowing what we don’t know. Investors should take account of expected worst-case scenarios into the asset allocation decision.”

The Labour Pension Fund, for instance, has started including value at risk (VAR) for each asset in its forward-looking asset allocation plan, noted Chiu Shean-Bii, president of Taiwan’s Pension Fund Association.

“This is big progress,” he told the conference. “Although having VAR projection doesn’t mean you have a complete risk-management mechanism, at least it is an indication of what kind of risk you are facing in each individual asset class.”

Recent events, such as the earthquake and tsunami that hit Japan and political unrest in the Middle East and North Africa, have shown investors that they must adapt their strategies in a risk-filled world, says Chiu.

But while such global events present systemic risks, high inflation at home has also driven principal protection to the top of institutional investor agendas in Taiwan.

“The biggest concern nowadays to [Taiwanese] investors is high inflation,” says Li. “But for Asian investors there are not many securities they can choose from to hedge against inflation. If you choose instruments in the US or Europe, it does not match local inflation in Asia.”

She noted that pension funds worldwide tend to have a home-bias in terms of their asset allocation. “It is not uncommon if their local asset allocation is over 50% to match local inflation,” she adds.

Chiu, meanwhile, said that while pension funds in Taiwan had globally diversified portfolios, they were only investing in traditional assets, which could not deal with all kinds of crises. “I think the trend which needs to happen is to move to alternatives,” he said, adding that the Labour Pension Fund was preparing counter inflationary mandates, including funds invested in commodities.

Steve Tsai, head of corporate trust at Chinatrust Commercial Bank, also urged investors to be proactive in taking on risk since risk and return co-exist. He believes instruments such as convertible bonds and underpriced IPOs will generate good investment returns, with less downside risk.  

However, talking about risk management and acting on it are two different things. Tsai noted that it was still hard to convince investors to pay a premium to buy protection in Taiwan such as hedging tools. He said stop-loss discipline is another thing that all investment managers need to bear in mind to control down-side risk.

“The majority of pension funds in Taiwan were set up at a time of high interest rates, which means to reach break-even they need 5% to 8% return,” Chiu added. “So you want to control your risks, but at the same time return is also very important.”

He said a strict stop-loss discipline isn’t easy to follow, pointing out that, even if it is written on the contract, external managers of pension funds find it hard to execute stop-loss orders and accept realised losses. In-house managers are also wary of stop-loss orders for the same reason.

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