The international investments program initiated in 1990 by the Ontario Teachers' Pension Plan, Canada's largest public pension fund, had created a large exposure to currency risk. Some successful tactical currency hedging activities in 1995 prompted management to pursue the possibility of a structured foreign currency hedging program. The issue before management was whether such a hedging program should be undertaken and what form it should take.
In 1994, William Booth, a member of the management team of the Ontario Teachers' Pension Plan Board, was asked to re-examine the diversification strategy that the $30 billion fund had been pursuing since its inception and to determine an optimal long-term asset allocation policy for the fund. After inheriting a portfolio that consisted entirely of fixed-income securities in 1990, by the end of 1993, the allocation to equity was only 20% short of a 1995 interim policy target of 66%. Booth's primary task was to determine whether the shift in asset mix should stop at 66% equity in 1995, which was above the allocation to equities for the average pension plan, or whether it should continue to some higher amount (an independent consultant recommended an 80% allocation to equity). Booth knew that a higher allocation to equities would likely increase total returns over the long-term, thereby reducing the cost of funding the plan. However, equities exhibited greater volatility than bonds and a higher allocation to equities therefore created some risk that future funding costs might rise above current levels.
The Ontario Teachers' Pension Plan Board, Canada's largest pension fund with over $40 billion in assets, had just listened to a presentation addressing a method for identifying and controlling the pension fund's exposure to market risks known as Value At Risk. The Board needed to understand what Value At Risk represented, what assumptions went into the risk management systems and how it might impact on policy decisions. This case introduces students to the risk management of investment portfolios, highlighting benefits and limitations.