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The Actuary The magazine of the Institute & Faculty of Actuaries

A wider definition of risk

When discussing default investment funds for defined contribution schemes (in the March issue of The Actuary) Alistair Byrne and Debbie Harrison consider that ‘all of the default fund categories can be regarded as relatively risky, with fairly high equity contents’. They appear to be using ‘risky’ as a synonym for ‘volatile’, a usage which is more or less universal in the investment world.

As actuaries, we should be more discriminating. Risk is not a concrete entity, sitting out there in glorious isolation waiting to be identified. There are only risks in relation to goals, or other desirable outcomes. When you are discussing the riskiness or otherwise of various courses of action it’s important to be very clear about the context. The risk to what?

In the case at issue, the following risks spring to mind; there may well be others:

  • the member’s assets at retirement are less than the contributions made;
  • they are less than was forecast;
  • they are not sufficient to provide an adequate pension;
  • the rate of return calculated at retirement is less than inflation;
  • the rate of return is less than that on an investment that happened to perform well over the period in question (isn’t hindsight useful!).

The latter risk is probably more serious for the scheme provider than for the individual member. Investment in cash provides a way of limiting the first risk, though it may feed the other risks rather than control them. Volatile investments are less risky if there is no fixed date at which they have to be realised.

The point is that in order to control risk you have to be very clear as to what the risk is. Different strategies are appropriate for different risks, and the various parties to a transaction will often see the risks differently.