Risks to the performance tracking error for the FRR and its investment managers relative to their benchmarks

The volatility of deviations between the perfor- mances of the strategic allocation and the real allocation is measured by tracking error (TE) type indicators. This concept is defined as the annualised standard deviation in performance between the real portfolio and the benchmark allocation target.

On the whole, the investment managers all respected the TE limits set in certain manage- ment mandates in 2016, albeit with a few minor breaches, mainly when introducing new mandates.

At the end of 2016, the ex-ante TE between the FRR s real portfolio and the strategic allocation was 93 bps. This takes into account the effects of selection (active management of fund man- agers, choice of indices different from the stra- tegic allocation, etc.) and flexible management (tactical over or underexposure of asset classes, and adjustments to interest rate and currency risk hedging).

As well as allowing new investment grade credit mandate managers to diversify into lower rated issuers, the FRR established a framework for their management by setting a new limit relative to their benchmark. This is based on measuring the Duration Times Spread (DTS) of all securities in their portfolio, reflecting the level of credit risk taken through two expressions: the amount received by investors to reward the risk taken (the spread or risk premium); and the length of exposure to this risk (the duration). A compari- son of each manager s portfolio DTS against the benchmark (limited to investment grade securi- ties) can be used to assess and limit credit exposure relative to the benchmark.

Risk on financial contracts, in particular derivatives

To enable the FRR to invest securely in forward financial instruments, the regulatory authority decided in 2001 to subject the FRR to a legal framework similar to that applicable to coordi- nated UCIs.

The FRR applies the risk monitoring principles for transactions in financial instruments set out in the AMF regulation3 of November 2011 on the

3 Autorité des marchés financiers (French Financial markets Authority).

method for calculating the overall risk of UCIs. These principles specify two calculation meth- ods implemented by the FRR: a method of calculating the commitment under a financial contract for non-complex derivatives;

a method based on VaR calculations in the case of the large-scale use of complex finan- cial contracts.

The FRR uses the commitment method to calcu- late the overall risk. This method consists in cal- culating the actual commitment of the financial contracts in relation to the Fund s total net value. The value of the commitment at the end of 2016 was 25.86% of the fund s value, as com- pared to 18.40% at the end of 2015. It is there- fore well below the regulatory 100% limit, even including the systematic option-based hedging designed to control the volatility of some of the equities held by the FRR (as initially provided for in the 2015 strategic allocation).

Liquidity risk of assets under management

A holding limit on UCIs was introduced in the ruling of 24 May 2016, which set this at 20% (previously an internal limit).

The FRR also manages a holding limit on com- panies equity: the FRR may not hold more than 3% of the shares of a single issuer, with the exception of the unlisted real estate asset and private equity portfolios.

OPERATIONAL RISKS This is the risk of loss resulting from inadequate or failed internal processes or external events, regardless of whether they are intentional, acci- dental or natural.

Internal and external operational incidents are catalogued and analysed as and when they occur. They are presented and monitored at Risk Committee meetings (corrective action, com- pensation, improvements). They are also moni- tored regularly by the Audit Committee. In this way, the FRR keeps track of operational inci- dents and regulatory sanctions affecting its providers of delegated management services, as well as its core service providers.

In fulfilling its role, it is important that the FRR should be able to carry out its main activities without disruption in the event of a serious inci- dent such as the collapse of a supplier, flooding