InvestmentRiskExecutiveSummary-DVv3-NCTreasurer.pdfVIP

Investment Risk Investment risk is a complex topic that has been the subject of extensive academic research by some very intelligent people. We have tried to distill the bits of this field that are relevant to our discussion into the following few pages, but if you wish to understand more of the theoretical underpinnings, the staff can recommend additional texts. Non-Systematic Investment Risk Non-systematic investment risk is the risk that a single security will drop in value. For example, consider some former employees of Enron who put most of their 401(k) assets into company stock. They were taking on significant non-systematic risk by investing in a single security rather than in a broad portfolio of stocks and bonds. Non-systematic risk can be easily eliminated at little cost by holding a diversified portfolio. Such diversified portfolios are commonly held by defined benefit pension trusts and are also generally available to defined contribution investors through a diversified offering of mutual funds. The only significant source of non-systematic risk that remains in the pension world is company stock. The use of company stock in 401(k) plans has declined since the Enron debacle and is irrelevant to our discussion anyway since state and local governments obviously do not issue stock. Systematic Investment Risk As many investors saw in 2008, a lot of risk remains in a diversified portfolio. This remaining risk is called systematic or market risk. It is the risk that the broad stock and risky bond markets all decline in value at the same time. Because this remaining risk is so significant, the Commission will need to address which party should bear it. Asset Classes To simplify the discussion, the Commission could consider only two types of assets: risky and non-risky. While questions of proper asset allocation between domestic and international, small cap and large cap,