McFate, after spending two decades in the insurance industry,
became the chief investment officer for Xerox in late 2006. In early
May, she sat with ai5000 to discuss the intertwined topics of market
uncertainty and risk management.
Carol McFate
Protecting from Risk
Let’s take a step back—how I think about the job that I am in. Historically, it has been viewed as an
investment manager, but I think of myself as a risk manager—this being partly a result of spending
more than half my career in insurance. It’s about being more risk aware with regards to your
liabilities. Coming into this field three and a half years ago, I was struck by the discussion of LDI and
whether one should extend bond duration. People were thinking about liabilities, but there was still
an investment return motivation behind it. Today, partly as a result of the financial crisis, CIOs are
more focused on having a concrete game plan for how they want to extend duration and a strategy
for achieving fully funded status. It is really refreshing. The flip side is, if you’re going to increase
your fixed-income exposure, typically your expected return is going to drop; depending on how
that plays into the corporate side, there can be tension. It’s a question of how to balance issues; this
is what CIOs, Treasurers, and CFOs care about. Investment management and Treasury functions:
it’s hard for me to think of one without the other because both are looking at risk. Correspondingly,
when I am looking at potential investment managers, I look closely at risk controls—I ask, ‘How
quickly did you understand what was happening during the crisis? What did you do about it?’ Still,
this is a highly uncertain environment—with deficits and other fiscal challenges. No one who sits in
the CIO seat can anticipate what the playbook is. It’s also about reducing volatility. With pensions
moving toward the stage where they’re being closed or terminated, there is a desire to take risk off
the table, and there is a move toward an investment management strategy more focused on reducing
volatility. Before the crisis, asset returns were reasonably well behaved, correlations generally held
up, surprises were less severe—or at least more localized. Left-tail events during the crisis taught us
about abnormal behavior. The resulting liquidity challenges caused plan sponsors to think more
about the risk of the pension in context of risk to the sponsor. If you had the good fortune of being
long duration, you weathered it better than a shorter duration fixed-income portfolio. All these
issues stem from market uncertainty, of course. With the size of government spending, you’d
expect a steepening yield curve, but dynamics elsewhere still make us a safe haven. There is money
flowing into the dollar and Treasury market—which is contrary to what you’d expect. These two
issues—macro risks and risk management—weave around each other. You can’t have one without
the other—and CIOs are acutely aware of it. ”
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