Balancing inflation with investment risk

THE recent downturn in pension fund performance has thrown the spotlight on to how pension funds are run and whether fund managers are taking too much risk with employees' funds.

The challenge for Hong Kong pension fund managers is to balance beating wage inflation while ensuring funds are not put at too much risk.

The latest figures show pension funds lost about 12.5 per cent in the first quarter this year.

Grahame Stott, Wyatt's managing director, said: ''If you are going to try to beat a 13 per cent rate of return, you unequivocally need to take on a fair amount of risk.'' Just how much risk is something that employees typically have little influence over.

Because most pension funds in Hong Kong are charged with delivering returns higher than inflation, money managers usually take on more risk in the form of stocks, which typically account for 80 per cent of a portfolio.

If the share market drops, as it has this year, so does the value of the fund.

Schroders Asia director Richard Haw said pension fund performance should be looked at over the long term.

''The challenge is to keep the long-term rate of return ahead of the rate of inflation so performance should be judged likewise.'' A comparison with other countries shows why it is difficult for Hong Kong pension managers to come up with good returns and lower volatility.

In Germany, where the rate of inflation is about three per cent, most of a pension fund portfolio is allocated to low-risk government bonds with a low return.

Hong Kong pension fund managers must cope with 10 per cent inflation and, therefore, allocate more of their portfolios to assets yielding greater returns.

Most pension funds allocate the majority of their funds to stocks and, last year, they accounted for 83 per cent.

Of those, half was allocated to Hong Kong stocks or Southeast Asian markets and the rest put into more mature markets.

This high-return strategy has proved successful over the long term but is not without its risks.

For a more conservative approach, the best option is a guaranteed fund, which offers a guaranteed rate of return.

However, these funds usually cannot match the inflation rate in Hong Kong because they are based on bonds that are typically low yielding.