Wide-angle lens approach to managing volatility

Share on facebook
Share on twitter
Share on linkedin
Share on email

(pictured: Thomas Lee) 

Smoothing the journey to retirement through various defensive strategies has generally been assumed to cost the member in terms of the end outcome. A paper by Parametric Portfolio Associates shows that this outcome, or ‘destination’, can also be enhanced in a defensive strategy.

Parametric has published a paper that argues that it is possible to reduce volatility in an equities portfolio while continuing to grow retirement savings. The strategy involves de-risking an equities index, such as the S&P/ASX 200, while writing an options overlay which generates an additional and stable well-priced return stream.

The paper was written by Thomas Lee, managing director of investment strategy and research at the Minneapolis Investment Center at Parametric and Raewyn Williams, the Sydney-based director of research and after-tax solutions. They say concerns about the impact of volatility have been elevated by things such as fund portability, short-term performance reporting and demographics surrounding retirement. But solutions exist by taking advantage of the volatility risk premium.

On a visit to Australia last week, Thomas Lee said that the firm’s ‘Defensive Equity’ strategy could add 50bps or more to a portfolio which had been partially de-risked through adding 50 per cent in sovereign bills to an equity index. Parametric is currently running about US$4 billion in the strategy in the US and more against the MSCI ACWI index.

“We [Parametric] are known for providing meaningful outperformance through efficient strategies,” he said. “No-one’s afraid of upside volatility. We can structure the de-risking to capture some of the volatility premium too.”

Raewyn Williams said the three standard responses to the volatility issue in retirement are each deficient in some way. They are:

  • taking the ‘edge’ off the portfolio through some factor-based defensive strategy which still leaves a fairly ‘rocky path’
  • de-risking through changing asset allocation, which results in a trade-off of member returns for a smoother path, and
  • buying some kind of protection, or volatility dampening, which tends to be expensive.

“We think that there is a better way to smooth the path [of returns] without giving away so much,” she said.

The paper says: “As funds rise to the challenge of managing volatility, we ask them to take a ‘wide-angle lens’ view of the problem. It is not only the journey, but also the destination that counts for members.”

Share on facebook
Share on twitter
Share on linkedin
Share on email