the implementation

To implement this approach, a strong governance framework is required. More specifically, buy-in from management and the Board of Directors regarding the proposed approach is required. There should also be appropriate escalation mechanisms with an eventual tie-in to the incentive plan. Finally, the rating assessment process should be part of the investment process, and the risk team must have sufficient expertise and resources to keep pace with said investment process.

There are of course unique considerations to this approach, which should be well understood be-fore it is implemented. In terms of operationalization, it may appear difficult to implement the approach if the pension fund’s asset base is substantial, especially considering the various asset classes, sectors, and geographies it is invested in. Furthermore, continuous effort is required to ensure that a strong risk culture is maintained across the organization. Despite these challenges, the main benefit from this approach pertains to the overall process that enables a risk-aware culture with constant dialogue across all asset classes, management, and the Board of Directors.

References

1. Betermier S, Byrne N, Fontaine J-S, Ford H, Ho J, Mitchell C. Reaching for yield or resiliency? Explaining the shift in Canadian pension plan portfolios. Bank of Canada [internet]. 2021 August. Available from: https://www.bankofcanada.ca/2021/08/staff-analytical-note-2021-20/

2. Chen B, Greenberg D. Consistent Risk Modeling of Liquid and Illiquid Asset Returns. The Journal of Portfolio Management. 2017 September; 43[6]: 73-89

3. Treacy W, Carey M. Credit risk rating systems at large US banks. Journal of Banking & Finance. 2020 January; 24[1]:167-201

4. CDO Research Data Feed Glossary of Terms. Moody’s Investors Service [internet]. 2007. Available from: https://www.moodys.com/sites/products/productattachments/cdoglossary.pdf

François Audet Gary Van Vuuren

François Audet is a Managing Director and co-head of the Private Investment Risk group at PSP Investments. Since joining PSP Investments in July 2010, François has been involved in the imple-mentation of a comprehensive risk assessment framework for private market investments. By performing fundamental credit analysis and assigning risk ratings and internal covenants to each investment, François and his team have been assessing throughout the years the risk profile of the investments and the private market asset classes.

Prior to joining PSP Investments, François held various positions at CDPQ as well as GE Capital. François is a Chartered Financial Analyst (CFA) and a Financial Risk Manager (FRM).

Synopsis

In this article the author discusses a mechanism for gaining synthetic exposure to cryptocurrencies through the use of a technique that simulates the underlying with an algorithm that leverages the concept of delta hedging a derivative. An approach is described utilizing the basic Black-Scholes pricing model and Hull’s delta hedging algorithm that can replicate the trend in Bitcoin with observable market inputs (FX rates and short-term interest rates), which is tested on historical data to demonstrate the effectiveness of this hedging approach. This provides a valuable contribution for practitioners as a simple and effective solution to this problem that can be readily implemented in a spreadsheet macro.