Australian super funds bring derivatives into the mainstream


Michael Armitage

Australian super funds are embracing derivatives to perform a wide range of investment functions, according to a new survey by risk management and retirement specialist firm, Milliman.

The survey revealed that roughly four in five funds (79%) using derivatives ‘always’ or ‘often’ used derivatives for risk management and hedging while other popular uses included portfolio rebalancing and assisting with fund manager transitions.

“Milliman’s survey results show the Australian industry has a mature and healthy approach to derivative usage,” Milliman Head of Fund Advisory Services, Michael Armitage, said.

“Most super funds are using derivatives not only for risk management, but for dynamic asset allocation, physical security replacement and to enhance yield.

“Pleasingly, we also found no signs that derivatives were being used to take on excessive risk with 85% of funds stating they ‘never’ used derivatives to leverage exposure.”

Milliman’s Financial Risk Management division, Milliman FRM, is a global leader in providing advisory, hedging and consulting services to the retirement savings and insurance industries, managing across US$152 billion in global assets as at 30 June 2017. Milliman FRM employs over 150 professionals in Chicago, London and Sydney.


The most popular method to employ derivatives was through an overlay structure (65%), followed by an external manager mandate (47%), and as a core component of asset allocation (26%).

“Funds understand that derivatives can improve efficiency and lower costs, which is extremely attractive in a low return environment,” Armitage said.

“Risk management and hedging continue to be main areas of derivative usage. However as an ageing population is faced with increasing exposure to sequencing risk and demand more retirement-focused products, funds will increasingly turn to more explicit portfolio protection strategies using derivatives to manage more complex retirement dynamics.”

“Insurers and defined benefit funds face similar asset-liability challenges and Milliman, as an implemented actuarial consultant, has built decades of experience helping those organisations manage the impact of volatility and capital loss to their balance sheets. As we witness a change in financial planning to goals-based advice, we see many of these techniques being adopted to improve long-term outcomes and minimise short fall risks to individuals.”

Surprisingly, 69% of MySuper funds and 63% of choice/pension products still don’t use any explicit downside protection strategies despite the global financial crisis exposing the limitations of diversification as a risk management strategy. The Comprehensive Income for Retirement Products (CIPR) discussions can be expected to bring into focus the need to address the dynamics of pension phase for members.

“Funds utilising downside protection in the pension phase are expressing growing concern with fixed income’s ability to provide diversification benefits given a potentially rising rate environment. Others are focused upon managing investor behaviour and smoothing portfolio performance to help members achieve their retirement goals.”

Overall, for funds that chose not to use derivatives, 32% believed they could meet their objectives without them, 18% were concerned that the complexity outweighed the benefits, and 9% cited the negative perception surrounding derivatives.

The survey also found the vast majority of Australian funds (91%) used ISDA master agreements to trade OTC instruments in contrast to Milliman’s global survey, which showed an international shift away from OTC derivatives and towards exchange-traded instruments.

More than half (53%) of all Australian funds used ‘third party’ ISDA master agreements, which are easier to implement than negotiating direct ISDA agreements but can also increase counterparty risks by introducing a third party between the fund and the bank. Only 19% of funds used direct ISDA agreements while 19% of funds used both direct and external agreements.

Milliman FRM acts as a fiduciary providing non-conflicted advice to its clients. Milliman’s implemented consulting and execution services rely on its purpose built global trading platform and experience advising some of the largest financial institutions globally.  Australian clients include Maritime Super, BetaShares, Plato Investment Management and Colonial First State.

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