Helen Prior looks at how using an alternative approach to de-risking is a safer way to reduce liabilities.

Alarm bells should be ringing! "Why?" I hear you cry. We appear to be in a long period of steady growth with low inflation. Things are good, people are optimistic, what could possibly go wrong?

Well, all this stability is actually storing up instability.

As the late economist Hyman Minsky identified "Stability is destabilising". Times of prosperity can persuade firms, workers and investors that recessions and crises are a thing of the past, and result in taking on more risk.

For defined benefit pension schemes, where the objective is to improve the funding ratio, with as little risk as possible, it is never the wrong time to ensure the investment strategy is robust and resilient.

Rather than just investing for the good times, it is important to consider the impact of the good, the bad and the different.

What happens if growth slows down, or we head into another recession? What would you do? How well would you perform?

If you haven't already, there are four key steps which you can take:

Avoid the big bets

Most pension funds are still taking one or two big bets, with a lack of liability hedging often being the biggest one.

Although interest rates are low, if you continue taking this bet you need to do so consciously. Ideally, you would assign an expected return and risk to the position and consider the sizing of the position against other risks in your portfolio.

Many believe that interest rates will only go up from here, but just look at the yields available in countries such as Germany – can you really afford rates to fall from here?

Add some real diversification

Investing in assets that primarily do the same job doesn't really add much in the way of diversification – this is typically the case for a lot of active equity managers in portfolios.

To really obtain diversification it is important to add strategies that don't all move together in the same way and at the same time.

For example, combining equities with high yield and a relative value multi-asset portfolio could be one such step in the right direction. Many of the tools that can be used may not always be as familiar, but that doesn't mean that they are always more risky

Be bold

Not every asset or investment is going to perform at all points in time in an economic cycle.

The obsession with asset benchmarks means that you are essentially being forced to hold something, whether it will do well or not. Dealing with this can involve two actions.

First you should change your benchmark to mirror your fund's liabilities (if you haven't already) and second be prepared to make more changes to your portfolio along the way.

Changing the benchmark to mirror the liabilities means that you can reference each decision you make based on whether it is going to add value against the liabilities, or reduce risk – i.e. making the portfolio more efficient.

Making more changes to the portfolios merely involves capturing return when you think it is available, and looking to avoid losses. It probably sounds easier than it is, but the first step is a change in mind-set

Conventional is risky

We need to make pension funds more robust and resilient, and by considering the points above, this in itself will help you de-risk. Being alternative in this way is a good thing; being conventional may well be more risky.

Helen Prior, senior client manager, Cardano, www.cardano.com