In the newly created role, Wayne will be responsible for driving the growth of Wheelhouse’s Global and Australian Equity capabilities. He will focus on key accounts, research relationships, asset consultants, independent financial advisors and private wealth as Wheelhouse continues to build its base across the Australian Wealth Management market.

Mr McGauley brings 25 years’ experience in distribution, most recently at Investors Mutual Limited (IML) where he served as Head of Retail for 13 years and was responsible for setting and executing the IML Retail Strategy. Throughout his 17 years at IML he gained vast experience across all segments of the Wealth Management market.

Alastair Macleod, Wheelhouse Managing Director and Portfolio Manager, said, ”Wayne’s appointment is a significant milestone in Wheelhouse’s journey as a truly independent asset manager. Since launching our first global income fund five years ago, we’ve affirmed our lower risk and income generative approach and are excited to be building a dedicated distribution capability with Wayne’s direction and support. He brings tremendous wealth experience, knowledge and investor understanding, and we’re thrilled to be working with him as we continue to grow and expand.

Commenting on his appointment, Mr McGauley said, “I’m delighted to have been given the opportunity to build out the distribution capabilities of Wheelhouse. What attracts me to Wheelhouse is the expertise within the investment team and the refreshing different approach to managing specialist income strategies across both Global and Australian Equities.

“Having spent 25 years in distribution I understand clearly the needs of retail investors and I am confident in Wheelhouse’s capabilities to deliver consistent and growing income over time, through a systematic process that consistently prioritises risk management. ‘No surprises’ is key for me when it comes to investment returns and I share Wheelhouse’s intense focus on delivering reliable investor outcomes.”

Mr McGauley’s Head of Distribution role is effective 1 October 2022 and based in Brisbane.

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Alastair MacLeod

The flagship fund of Australian-based specialist income manager Wheelhouse Partners, the Wheelhouse Global Equity Fund, is now available to Australian retail investors through the BT Wrap and BT Panorama platforms.

The Fund is unique in that it combines a targeted 7-8% income return with ‘always-on’ tail or crash protection, designed to partially protect the portfolio during any market sell off.

Alastair MacLeod, Managing Director of Wheelhouse Partners, commented, “With equity markets approaching all-time highs and interest rates at all-time lows, the demand for strategies with an absolute return focus is increasing.

“Our strategy offers investors, who are being pushed further along the risk curve in their search of yield, a highly novel income solution without them having to expose their capital to full market risk.  Retirees in particular can be severely affected if their capital base is impaired, resulting in a weaker income generation. This is why the Fund prioritises capital preservation and income generation.”

The Wheelhouse Global Equity Fund is among the lowest risk long-only global equity strategies available in Australia, due to its highly defensive investment approach that invests in global equities but also applies a specialist derivative overly to target income plus capital preservation.

The Fund’s absolute return characteristics were evidenced during the coronavirus affected March 2020 quarter, where the Fund delivered a positive 2.2% return.  During this period the Fund’s protective tail hedge that sits embedded within the portfolio, materially appreciated in value, serving to offset and mitigate equity losses. Coupled with the Fund’s defensive currency benefits of owning unhedged global equities, these twin defensive exposures combined to fully mitigate capital losses for Australian investors.

“We are excited to be working with BT and broadening our distribution footprint in Australia,” MacLeod said

“There is a genuine scarcity of specialist retirement income strategies designed for Australians, and the distribution arrangement with BT means many more advisors and retirees around the country will be now able to easily access the fund.”

The Wheelhouse Global Equity Fund was rated ‘Recommended’ by Zenith in 2020.

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Alastair MacLeod

Research house Zenith has awarded a ‘Recommended’ rating to the Wheelhouse Global Equity Income Fund managed by Australian-based specialist income manager Wheelhouse Partners.

The fund’s global equity strategy aims to deliver a 7-8% annual income return, plus some capital growth, while assuming 40-50% less risk than the equity benchmark.

”Zenith believes Wheelhouse has thoughtfully designed the derivative overlay to generate a growing and consistent income stream. Furthermore, Wheelhouse has efficiently managed the costs of its protection and has demonstrated an ability to deliver upon its capital preservation objectives,” the Zenith report says.

“Wheelhouse’s investment approach is differentiated and appealing for investors who are income focused. In addition, we draw confidence from the investment outcomes produced by the Fund in periods of market distress, which were consistent with expectations.

“Overall, Zenith believes the Wheelhouse team has a wealth of experience relating to the options market and risk management, which ensures that the Fund’s risk management processes are strong.”

Alastair MacLeod, Managing Director of Wheelhouse Partners commented, “We are very pleased that Zenith’s first rating of the global fund acknowledges the quality of the investment strategy, as well as the scarcity of genuine income generative investments in the current market environment.

“The fund’s focus on capital preservation has also been recognised, an element we believe is paramount with markets touching new highs amidst widespread economic uncertainty. These defensive characteristics were amply demonstrated when the coronavirus pandemic spread globally, with the Fund posting a positive year-to date performance through to March 31, 2020,” MacLeod said.

Over the past three years to 31 July 2020, the Wheelhouse Global Equity Income Fund has delivered a total income return of 7.4%, plus unit price growth of 2.0%, for a total annualised return of 9.4% per annum. From a risk perspective, the fund beta has been 0.59 during this period, reflecting the meaningfully lower risk investment approach. A beta of 1.0 means equivalent risk to the benchmark.

The fund’s investment approach is based upon integrating a systematic, rules based derivative overlay with a portfolio of quality focused, global listed securities. In addition, actively managed downside protection strategies, known as ‘tail hedging’, are designed to protect capital in a drawdown and limit losses.

Wheelhouse Partners was launched in April 2017 and has recently completed a successful transition to an independent fund manager with specialisation in income generation and capital protection.

The Zenith rating follows on from the ‘Investment grade’ rating issued by Lonsec in 2019.

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The revised structure includes a new co-investor in Wheelhouse, Alan Howard.  Mr Howard is a co-founder of Brevan Howard Asset Management LLP, the UK hedge fund where Wheelhouse trader Andrew MacLeod and chief information officer Sam Jacob worked for many years across several markets.  Mr Howard replaces Bennelong in the capital structure of the business.

Managing Director of Wheelhouse, Alastair MacLeod, said Mr Howard’s investment represents a tremendous vote of confidence for the business which began operating under Bennelong’s structure over three years ago.

“While volatile market conditions have played to our strengths, we remain steadfastly committed to the core objectives on which Wheelhouse is founded; to generate a reliable, consistent income stream whilst preserving investor capital from market downturns,” MacLeod said.

“For the first time in decades, investors are facing falling dividends, fewer traditional income yielding options and inflated asset prices across the board, which is transferring more risk to capital bases.

“Our global strategy seeks to address these concerns, targeting a high-income yield whilst safeguarding our investors’ capital.

“The time is right for a differentiated investment approach and we are excited to be in a position to invest in our business and create solutions for investors to help navigate this challenging environment.”

The MacLeod brothers are based at Wheelhouse’s headquarters in Brisbane, while Sam is based in Sydney.

The team will be supported by recently appointed Chief Operating Officer Tony Hammond, well known in Australia’s funds management industry for his stewardship of fast-growing boutique investment managers.

Hamel Strategic Partners will head up distribution efforts for Wheelhouse, led by Andrew Aitken, the former Head of Distribution at Bennelong, and Cameron Dickman, formerly Head of Distribution at AMG and Australian Unity.

The Trust Company (RE Services) Limited (Perpetual) is now the Responsible Entity for the Wheelhouse Global Equity Income Fund.

The team has completed extensive testing of an Australian equities focused fund, applying the same rules-based and disciplined derivatives strategy to that of its flagship global fund, however over an index of Australian listed securities.  The local fund is expected to be rolled out to Australian retail and wholesale investors later this year.

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Under its independent ownership structure, Wheelhouse will continue to focus on delivering purpose-built investment solutions that target income and protection for Australian retail and wholesale investors, including its flagship Global Equity Income Fund.

The fund’s net positive returns year-to-date are attributed to its rules-based systematic approach to preserving capital, particularly in market crises, while continuing to generate consistent income.

Alastair MacLeod, Managing Director of Wheelhouse, said, “We are excited to take full ownership of our business and extremely grateful to Bennelong for its support in establishing and positioning Wheelhouse for future success.

“We remain fully committed to delivering defensive income for Australian investors challenged by today’s ‘lower for longer’ equity growth environment and historically low interest rates. We look forward to leveraging our track record and momentum to pursue new opportunities.”

Bennelong CEO, Craig Bingham, said “We are proud to have partnered with Wheelhouse, and look forward to seeing them continue to flourish.

“Over the past three years, Wheelhouse has focused on its objectives of generating income, protecting capital and lowering volatility – timely offers for today’s market. We wish them well as they enter their next phase of growth and development.”

“Across the industry, this is a time of change and undeniable challenges, but we’re also seeing the arrival of new opportunities,” said Craig. “At Bennelong, we continue to refine and strengthen our global capabilities, managing the business to deliver the best possible outcomes for our clients.”

Wheelhouse has agreed terms with new distribution partners and has appointed a new responsible entity for its offerings, which will be announced later this month. The team also plans to launch an Australian equities focused fund, which will apply the same rules-based and disciplined derivatives strategy used for the global fund.

The buyout and transition arrangements will be finalised by 31 July 2020.

-oOo-

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Alastair MacLeod

Retirees should ensure they have a well-designed market crash protection strategy in their portfolios to help reduce the impact of inevitable downturns, particularly in the current low interest rate environment, says Alastair MacLeod, managing director at Wheelhouse Partners.

Mr MacLeod believes the portfolios of many retirees are not adequately constructed to withstand the likelihood of an imminent turn in market fortunes, but said it’s not too late to position themselves appropriately.

“Crash protection is like having little sleeping securities – they are always there, ready to wake during times of crisis when investors need them.

“They mean that investors can remain fully invested in order to make the most of equity returns, but at the same time ensure a valuable layer of capital protection,” he said.

Mr MacLeod said the move into retirement introduces new risks that don’t exist when people are working, and it’s important that investment objectives can pivot.

“Most investment strategies are designed for people in the accumulation phase, but those entering retirement need to reassess their investment approach to make sure it still suits their needs,” he said.

Many retirees increase their portfolio allocation to cash as a way of minimising the impact of any downturn, an understandably cautious approach. However, while cash is the lowest risk asset available to investors, it’s also the lowest returning.

“In the current environment, with returns from cash so low – and interest rates predicted to fall further – retiree investors need to consider other options.

“For example, a crash protection strategy using derivatives or ‘put’ options can limit losses to 50 or 60 percent of the market’s fall in a correction, but only cost the investor between one and two per cent over the course of a year,” he said.

Like insurance, crash protection is bought for a certain period (such as 12 months) and is attached to a certain notional value. The premium is also significantly cheaper if the investor wears the first few percentages of declines, in the same way that house insurance is less expensive if a larger excess is taken on.

One key advantage of crash protection is that it allows the rest of the portfolio to remain fully invested in the pursuit of equity returns, Mr MacLeod said.

“This can have a meaningful impact on long-term investment outcomes.”

He warns that crash protection isn’t a quick fix solution for every investor.

“Any worthwhile crash protection strategy needs to be tailored to the underlying portfolio exposures, and match the risks present. If the strategy hasn’t been designed properly, it will not only be more expensive, but it may not provide the desired protection,” he said.

In addition, crash protection needs to be actively managed in order to maximise its effectiveness. But in a low interest rate environment, the defensive qualities of crash protection permit a retiree’s portfolio to be more fully invested, harvesting steady income streams and accessing equity rates of return, thus reducing the risk of capital erosion and critical failure.

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A thorough understanding of the ‘emotional magnets’ that pull us away from rational decision-making can assist in retirement strategy design.

Using prospect theory to align retirement design with real world outcomes

Introduction

Most people are aware that buying lottery tickets makes no sense. From a rational assessment of risk and return, the value of the ticket is probably less than the paper it’s printed on. And yet despite this, the lottery ticket industry continues to harvest its outsized return – in part because of our humanistic tendency to overweight low probability events and make decisions on this basis.

The same behavioural forces are at work during times of market volatility or crisis. Retirees in particular are evidenced to be most vulnerable to making decisions against their best financial interests, at the worst possible times. Despite many retirees having long-term, well-crafted investment plans in place, market volatility can turn these plans into ‘impatient capital’ overnight, with extremely damaging consequences. Unfortunately it’s common to hear the story of a friend or relative who, driven by fear, moved to cash at the bottom of a market cycle.

The primary reason for this seemingly irrational behaviour is our cognitive bias – instinctive decision-making that is hard-wired into us at birth. This was the focus of Daniel Kahneman and Amos Tversky’s pioneering work on prospect theory, which has formed the bedrock of modern behavioural finance theory. Prospect theory holds many of the answers as to why humans tend to lack reason when it comes to financial decision-making.

We believe a thorough understanding of the ‘emotional magnets’ that pull us away from rational decision-making can assist in retirement strategy design. By recognising these cognitive biases – and importantly, by building retirement portfolios that take these biases into account – we believe retirees are better placed to adhere to their long-term plans and thus realise their targeted outcomes. Advisers, too, know that a less stressful financial journey makes for a happier client/adviser relationship, where both parties benefit.

What is prospect theory?

The term ‘prospect theory’ describes how people choose between different options (or prospects) and how they estimate (many times in a biased or incorrect way) the perceived likelihood of each of these options. It was pioneered by Daniel Kahneman and Amos Tversky in 1979 as a pragmatic model for explaining real-world choices and how these can systematically override optimal decision-making in many situations, especially financial. The theory has been lauded as a milestone in economics, and based on citations is regarded as one of the most influential studies in explaining how human cognitive biases can often impair rational decision-making processes.

The theory was a dramatic departure from previous utility-based models, whereby academics portrayed human decision-making as perfectly rational and argued that probability-weighted outcomes would serve as the basis for determining risk and return. Utility theory was based in part on the view that investors would focus on the final wealth outcome, or the probability-weighted return, and rely on this as a key consideration in decision-making.

Kahneman’s key departure from this view was that in the real world, investors are more likely to prioritise gains or losses from a current reference point and treat these gains or losses differently from a value perspective. In other words, the path of investment returns is more important than the final wealth destination.

A critical consideration in assessing this path is the concept of loss aversion. This is illustrated in the following chart, where for a given gain or loss, the perceived value is treated very differently. At the breakeven reference point (0), the value function is kinked and losses deliver significantly greater negative utility than equivalent gains.

Put simply, the pain felt from losing $100 is sharper than the joy of making $100.

• Gains/ losses relative to a reference point are more important than overall wealth at the destination (the path of returns matters).
• Value function is kinked at the reference point (0). The fear of losses loom larger than the prospect of equivalent gains (Kahneman estimates 2:1 for losses and 1:1 for gains close to the reference point).
• The function is concave for gains and convex for losses.

There are a number of other ground-breaking conclusions to come out of prospect theory (explaining why Kahneman was awarded a Nobel Prize in 2012), some of which are outlined below.

Overweighting small probabilities

This is the main feature of the probability weighting function (refer to the following chart), and explains the simultaneous demand for both lotteries and insurance.

Insurance is the mirror image of the aforementioned lottery tickets – whereby even though the likelihood of a costly event may be miniscule, most of us would rather agree to a smaller, certain loss (the premium paid) than risking a large expense. The perceived likelihood of a major health problem is greater than the actual probability of that event occurring. There’s a reason insurance companies are some of the oldest on the planet.

There are numerous examples of people under-estimating more frequently occurring or common risks. For example, a recent study of Australian hospital data^[i] reports that that nearly 40% of all injury-related hospital admissions in Australia were due to falls, versus 13% for transport accidents. For Australians aged over 65, the rate for falls increases to more than three quarters of all hospital admissions. And yet most of us perceive driving to be a riskier activity than the daily event of taking a shower.

There is an extension to this bias, where it is observed that people will ascribe more weight or value to the complete elimination of a given risk, as opposed to an equivalent reduction in risk. This principle is often evident in the pricing of insurance, where risk removal is priced differently to risk reduction (witness a high excess versus no excess and the subsequent effect on an annual premium). It is also often reflected in the pricing of many capital protected type instruments.

The following diagrams highlight the concepts of loss aversion, overweighting small probabilities, and an investor’s focus on relative gains or losses (the path of returns) as opposed to the final wealth outcome.

The first example shows that investors are far more likely to accept potential underperformance in exchange for increased certainty of a gain. When gains are being considered, ambiguity is penalised and investors opt for the certainty of $900.

Conversely, when losses are under consideration, the sting of loss looms large and investors take more risks to avoid it. By overweighting the low probability of a $0 loss, investors gravitate to the riskier option even though they should be completely indifferent as to the probability weighted final wealth outcome.

Framing and mental accounting

Framing describes the tendency for people to use a reference point as the benchmark for comparisons. As mentioned, this is a key difference to utility-based models which focused on final wealth outcomes.

In the example below, investors are given an initial sum of money and asked to choose between alternate scenarios. In either case the final wealth positions (total gains) are exactly the same across both scenarios. Under utility theory, an investor should choose the same option in either scenario – but in reality this rarely happens. The starting point matters, as it determines the path to the final wealth destination.

In Scenario 1, investors are overwhelmingly more likely to accept a certain gain of $500 (risk-averse behaviour). However, when faced with relative losses, investors focus on minimising the sting of loss – even if this means the possibility of losing $1000 in order to deliver zero loss (risk-seeking behaviour).

When gains are being evaluated, ambiguity is penalised – but the preference for avoiding ambiguity is less established when facing the prospect of losses. In other words, investors are assessing their path and altering the perceived risks according to their biases, as opposed to focusing on the final wealth attained (which is equivalent).

Mental accounting is a similar concept to framing and, while part of prospect theory, was identified and named by another Nobel Laureate, Richard Thaler, in 1988. It describes the process whereby people have different ‘mental bank accounts’ for different expenditures. For example, people tend to have a greater willingness to pay for goods using a credit card than cash, even though they draw upon the same resource. Similar to prospect theory, people are unable to focus on the final wealth outcome, instead considering the individual transactions separately and once again focusing on the path of returns.

Diminishing marginal returns

Utility theory and prospect theory appear similar in that as wealth or gains increase (utility theory is focused on total wealth and prospect theory on relative gains versus a starting point), the marginal value or utility progressively declines. In other words, the joy felt from a $1000 investment moving up to $1010 is less than the joy felt from a $100 investment moving up to $110. The absolute gain is the same, but clearly we value relative gains differently to absolute gains.

What does this mean for retirement planning?

We believe a sound understanding of prospect theory can assist advisers and investors design better real-world portfolios that more closely align our humanistic behavioural biases with the path of asset class returns – and ultimately, investment outcomes.

It seems like common sense when markets are calm, but integral to a financial strategy delivering the benefits and outcomes it was designed for is the investor ‘staying the course’ and remaining invested with a consistent long-term strategy. By recognising the pull of our emotional magnets and incorporating these into a comprehensive investment plan, advisers can add value by increasing the likelihood that their clients stick to their long-term plans.

Based on this, it makes sense for investor portfolios to address the following three key criteria.

1. Loss aversion (via capital protection)

Losses are felt more acutely than gains, and – as the GFC proved – retirees are more likely to disinvest during market stresses (i.e. precisely the wrong time) than other age groups. This behavioural bias during drawdowns is compounded by the separate concept of sequencing risk, which can also serve to materially impair outcomes for retirees.

As such, capital protection is integral during periods of market weakness. Note that this usually only comes at some cost of foregone investment returns (i.e. without risk there can be no return), and hence some approaches to capital protection can perversely increase risk as they simply increase the certainty of investment returns not delivering a portfolio’s objective. The key is to improve the shape of returns to minimise drawdowns – delivering a growth profile with capital protection.

2. Certainty effect (via higher income)

Investors value more certain returns above more ambiguous returns. In an equity landscape, we believe this helps explain the typical Australian retail investor’s focus on distributions, where regular bank account deposits can unfortunately be prized more highly than the accompanying capital fluctuations in the unit price. While there may be some comfort provided to retirees from regular payments, the more important metric is ‘total return’, which includes movements in the unit or share price alongside distributions.

Within this total return focus, income can play a critical role by providing:

• greater certainty, especially in low growth environments when real returns are difficult to generate, and
• increased predictability, as the range of possible investment outcomes can be narrowed.

3. Diminishing marginal returns (via a smoother return profile)

As above, an investor’s sense of value diminishes as gains increase, so a gain from $100 to $110 is less meaningful than a gain from $50 to $60. In this way, underperformance in a strong positive market is less important to an investor’s sense of value, especially in relation to stronger performance in a lower growth or negative market.

Prospect theory provides a framework for how investment decisions are actually made in the real world, as opposed to how they should be made in terms of maximising outcomes. Kahneman touches on the evolutionary origins of these behaviours, and that the instinctive, reactionary impulses that served us well for millennia need to be recognised as being less-suited for investment portfolios! 

Conclusion

Prospect theory is the bedrock of modern behavioural finance, particularly as it applies to our investment decision-making.

Unfortunately, as humans our ‘emotional magnets’ can wreak havoc with rational decision-making, particularly in times of a crisis. Long-term, well-crafted investment plans can turn into ‘impatient capital’ overnight, with damaging consequences. John Maynard Keynes is famously quoted as saying, “When the facts change, I change my mind.” Evidence suggests that retirees are particularly at risk of acting against their best financial interests at the worst possible times.

We believe retirement portfolios that are constructed to deliver growth, but with a return profile that mirrors our humanistic biases and includes elements of loss aversion and income certainty, can result in an increased likelihood of adhering to long-term plans and thus achieving better outcomes.

From an adviser’s perspective, it should also be noted that this less stressful investment path may lead to a more rewarding and fulfilling client relationship – which is in everyone’s best interest.

———

[1] Australian Institute of Health and Welfare, ‘Unintentional falls remain the top cause of injury hospitalization in Australia’, Canberra, 2012

This information is issued by Bennelong Funds Management Ltd (ABN 39 111 214 085, AFSL 296806) (BFML) in relation to the Wheelhouse Global Equity Income Fund. The information is current at the date of this article. The information provided is general information only. It does not constitute financial, tax or legal advice or an offer or solicitation to subscribe for units in any fund of which BFML is the Trustee or Responsible Entity (Bennelong Fund). This information has been prepared without taking account of your objectives, financial situation or needs. Before acting on the information or deciding whether to acquire or hold a product, you should consider the appropriateness of the information based on your own objectives, financial situation or needs or consult a professional adviser. You should also consider the relevant Information Memorandum (IM) and or Product Disclosure Statement (PDS) which is available on the BFML website, bennelongfunds.com, or by phoning 1800 895 388. BFML may receive management and or performance fees from the Bennelong Funds, details of which are also set out in the current IM and or PDS. BFML and the Bennelong Funds, their affiliates and associates accept no liability for any inaccurate, incomplete or omitted information of any kind or any losses caused by using this information. All investments carry risks. There can be no assurance that any Bennelong Fund will achieve its targeted rate of return and no guarantee against loss resulting from an investment in any Bennelong Fund. Past fund performance is not indicative of future performance. Wheelhouse Investment Partners (ABN 26 618 156 200) is a Corporate Authorised Representative of BFML.

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Alastair MacLeod

The market falls of the past few days will have left many investors exposed to significant losses if they don’t have a program in place to manage tail risk, says Alastair MacLeod of Wheelhouse Partners.

“A market downturn is inevitable. Whether we are seeing the start of that process now, or just a blip, is yet to be determined – but it will eventually happen.

“Indeed, our research suggests it will happen sooner rather than later. So-called ‘100-year storms’ in fact happen every eight or nine years, so it could be said we are now living on borrowed time since the global financial crisis hit just over 10 years ago.

“It’s therefore important for investors – particularly those approaching or in retirement, when sequencing risk becomes so critical – to have in place some kind of tail risk management program to protect themselves from the full impact of market downturns.

“Our approach recognises that, in retirement, the goalposts have moved and the focus should not always be to seek the highest return each and every year.

“Instead, the critical objective should be to reduce the risk of unfavourable outcomes, where a retiree’s lifestyle may be affected in some way because they were simply unlucky in the path of returns that were delivered.”

Mr MacLeod says the Wheelhouse active tail risk program has now engaged, and over the past two days has more than covered the cost of protection since the fund’s inception nine months ago.

“This means our investors have been protected from the worst of the market falls over the past few days.

“At the market’s low point yesterday, the tail risk program had lowered effective risk in the portfolio to around 57 percent of the market and significantly smoothed the return profile for investors, while at the same time remaining near fully invested and having every dollar pursue equity returns.

“Should the market fall further, this market risk level is expected to decrease, preserving capital more aggressively.

“If we were to enter a period of lower equity returns and increased market volatility, the fund’s high income and capital preservation characteristics should be well-placed to add further value,” Mr MacLeod said.

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Alastair MacLeod

A commonly held assumption is that catastrophic financial crises – “100-year storms” – are an infrequent occurrence, but far from being a once in a century event, data shows they are in fact happening every eight to nine years.

In terms of investment outcomes, this has a potentially devastating impact on retirees, warns Wheelhouse Partners in a recent white paper.

The paper, The retiree and the 100-year storm, explains that significant market falls seriously affect retirees because typically their asset balances are much larger; they have less time to recover from sharp losses; and they rely on their savings for income, often drawing down on their savings during periods of market volatility.

Alastair MacLeod, author of the paper and managing director of Wheelhouse Partners, says that while traditional approaches to managing this issue – such as using cash – are increasingly ineffective, there are opportunities for investors to continue their exposure to the growth of equity returns by reshaping those returns and thus reducing risk.

“Advisers and their clients must recognise the very different objectives of retirees, and adjust their portfolios with appropriate tail risk management strategies to accommodate longevity risk,” he says.

The paper shows that managing tail risk is important for anyone who relies on their wealth to fund their lifestyle or other ongoing liabilities or obligations – that is, anyone not in accumulation phase.

It outlines three key reasons why managing tail risk is important for these investors: sequencing risk, behavioural loss aversion, and diversification and liquidity.

Looking at diversification and liquidity in particular, the paper outlines how other risks tend to correlate during crises and the source of liquidity that equities can provide during these periods.

It says: “… historically in times of crisis, returns across asset classes have collapsed together as correlations spike – and thus the benefit of diversification as a risk management strategy evaporates.

“Many asset classes such as credit and real estate have historically demonstrated a sharp decline in liquidity during these crisis periods, meaning the most available or liquid source of capital may be equities – which is, unfortunately, often the asset class that has fallen the most.”

The paper also points out that “in many respects, the traditional means of managing tail risks are broken. The conventional solution to lowering risk in retirement has been to increase allocations to either cash or fixed income, which both serve to reduce volatility and preserve capital better in drawdowns.”

Instead, in today’s environment, derivatives should be considered as a way to harvest higher returns from more volatile asset classes while delivering a retiree-friendly return profile, says Mr MacLeod.

“We realise that for some people, derivatives are seen as complex or risky.  However, we emphasise that this is usually only the case when leverage is used.”

The paper describes three main ways that derivative overlays can benefit investors, if used appropriately:

• tail risk overlays mean assets can remain fully invested in the pursuit of equity returns;
• derivative overlays can add convexity to a hedge, meaning capital is increasingly protected the more markets fall; and
• multi-asset derivative overlays can exploit pricing inefficiencies of indirect hedging.

Mr MacLeod says that retirees get just one shot at their future path of returns and it is vital to get it right at the outset.

“As people approach and enter retirement, their financial course is unknown but already largely set. Their outcomes are dependent on the future returns with which they will be presented.

“We like to think that tail risk hedging strategies will help them sleep a little better at night,” he said.

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Alastair MacLeod

Wheelhouse Investment Partners has launched the Wheelhouse Global Equity Income Fund to the retail market. The fund has been available to sophisticated and institutional investors since May 2017 and aims to deliver improved investment outcomes to Australian retirees.

The fund addresses the dual concerns of market volatility and longevity risk, says Wheelhouse portfolio manager Alastair MacLeod.

“Large investment losses, particularly in the five to 10 years immediately preceding and after retirement, can be devastating for retirees,” Alastair says.

“This well-documented issue is known as sequencing risk. It’s particularly relevant for retirees and pre-retirees due to the large sums of money involved, the relative lack of time that retirees have to recover from losses, and the necessity for retirees to draw down income during these periods.”

The fund’s investment philosophy is based upon three pillars: investing in global equities as a growth asset to address longevity risk; shaping returns to be retiree-friendly with lower volatility, better capital preservation and consistent income; and delivering a lower-cost solution to help improve outcomes.

The fund’s underlying portfolio is based on the Morningstar Developed Markets Ex Australia Wide Moat Index, a semi-active index that was constructed specifically for Wheelhouse Investment Partners. The stocks comprising the index are based on the fundamental view of Morningstar’s team of more than 100 stock research analysts. The index composition changes quarterly, based primarily on selecting the most attractively-valued securities in the coverage universe.

All stocks that appear in the index are required to be rated ‘Wide Moat’ which, as defined by Morningstar, are companies with a structural business characteristic that supports a firm to generate excess economic returns for an extended period of time.

The fund’s strategy integrates a tailor-made derivative overlay, purpose-built for Australian retirees.

The move follows the partnership formed between boutique fund incubator Bennelong Funds Management and Wheelhouse Investment Partners in May 2017, which brought the number of partnerships Bennelong has with specialist asset managers to eight.

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