Risk Allocation

There are thousands of potential investment opportunities for the Fund. How do we choose the best ones?

Risk Allocation Process

We use a risk allocation process to:

  1. decompose each investment's risk and return - clearly understand what additional risks each investment brings, above the Reference Portfolio, and the return we expect to achieve to compensate for those risks; and
  2. allocate the risk and return - allocate capital to and from investments on a timely, consistent and commercial basis.

This second step is achieved through the use of risk budgets.

Each investment is assessed in three ways:

  1. we look at the drivers of expected return (essentially our beliefs about what gives rise to an investment opportunity);
  2. our confidence in the expected return (derived from our view of how well we understand the drivers and their transparency and credibility); and
  3. our view of how good a fit it is with our way of investing. This is derived from how consistent it is with our target operating model, our investment themes and our focus on Responsible Investment.

The better a prospective opportunity or existing investment satisfies each test, the higher its attractiveness ranking. For a prospective investment, a higher ranking means it is more likely that we will seek an access point – passively, directly or via a manager. Ranking is also key to sizing our investment - how much active risk we allocate to an opportunity.

For an existing investment, a higher ranking means that at the very least we are likely to maintain that investment. It may also mean that we allocate further risk capital to it. The reverse is true of a lower ranking: a likely outcome is a reduction in the size of the investment or a total, orderly, exit from it.

Key factors

The factors which give us the highest confidence are:

  • a high degree of consistency between our endowments and investment beliefs, and the investment;
  • the ability to gain a clear view of why the opportunity exists and why it will improve the portfolio;
  • alignment with our long-term investment themes,
  • low reliance on skill alone (including our own) as the driver of expected returns; and
  • the highest ability to identify and manage the investment risk ourselves.