Apparent diversification and near-term payments
A fictional pension institution expects substantial net benefit payments over the coming year. Its portfolio contains several funds that hold many of the same underlying equities, along with property assets that are not readily sold. An external manager recommends a product with a higher expected return and states that a single category limit is satisfied, so no further review is needed. The governing body has not examined the product’s underlying concentration, liquidity terms, costs or relationship to the liability structure. A proposed currency hedge may require collateral during adverse markets. No numerical legal limit or future return is stipulated. The exercise asks for a whole-portfolio review within current applicable law and the actual mandate rather than a product recommendation.
1. Which risks are hidden by the initial presentation?
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Several fund names can conceal overlapping exposures. Near-term payments require liquidity despite a long investment horizon, while property saleability and hedge collateral can create cash needs. A higher expected return and one category test do not establish overall suitability or risk capacity.
2. What should the institution require before deciding?
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Obtain clear information on exposures, valuation, liquidity, costs, collateral and mandate compliance. Relate the strategy to obligations, membership and stress scenarios. Document competent approval and continuing monitoring. Delegation to a manager does not make governing responsibility disappear or guarantee the projected return.