PVSWT is a value oriented, ESG aware Australian equities fund. The fund has a broad-cap focus and leverages the 20-strong Perennial Australian equities research team to identify opportunities across the full spectrum of large, mid, and small cap companies.

The trust has been upgraded by Lonsec from Investment Grade to Recommended. Lonsec’s conviction has increased and is underpinned by the quality and substantial experience of the tripartite portfolio management team, boasting an average experience of 22 years.

Stephen Bruce, Lead Portfolio Manager for PVSWT, said: “We are delighted to have received this rating from Lonsec for our flagship wholesale trust. Our approach has been proven throughout multiple market cycles, and we look forward to building on our 20-year track record. We are particularly excited by the opportunities being presented for fundamental-based investors to add value in the current market environment.”

As at September 2021, the Perennial Value Australian Shares strategy has delivered annualised performance of 9.5% since inception, net of fees.

Lonsec noted the well-resourced and highly experienced investment team, full coverage of the Australian market and “robust and repeatable” investment process.

PCAST, which is available to retail investors, received its first Lonsec rating.

Launched in 2017, the trust invests in a concentrated portfolio of 15-30 companies listed on the ASX, and also employs Perennial Value’s specialist value focus.

Dan Bosscher, PCAST Portfolio Manager, said: “We are pleased that PCAST has received this Recommended rating in its inaugural review by Lonsec. We believe the trust is well positioned to benefit from the post-COVID economic recovery – an environment that offers the potential for significant outperformance for value style investing.”

In its review of the trust, Lonsec said Perennial Value  exhibited many of the characteristics that Lonsec sought in a ‘boutique’ investment manager, including “equity ownership by the investment team, a strong alignment of interests and an investment-oriented culture.”

The post Perennial Value receives Lonsec ‘Recommended’ rating for two trusts appeared first on AdviserVoice.

After enduring the Global Financial Crisis (GFC), investors around the world reflected on the lessons learnt and started asking how they could better protect their portfolio should such a catastrophic event reoccur.

It is commonly accepted that any time out of the market will likely reduce portfolio returns. This is partly true as the market tends to go up in the long run, and an allocation to cash erodes the portfolio performance in a rising market. The age-old adage of “time in” versus “timing” the market still rings true today. But avoiding downturns and preserving capital will always create a better long term investment outcome, due to the effects of compounding.

The rising need for both portfolio protection and maintaining market participation has prompted investors to look at different types of protective portfolio overlays. Here, we compare two main types of overlays – futures or options based. We look at how they perform in different market scenarios, and which one suits investors’ needs best.

Why the type of overlay is important: Options or Futures?

Futures definition: Agreement to buy or sell a specified asset, at a future date, at an agreed price. Futures are a type of derivative.

Options definition: A contract which gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a specified price on or before a specified date. Options are a type of derivative.

The goals for both futures and options overlay strategies are often similar:

• To maximise the return of your portfolio in all market scenarios;
• To limit portfolio losses in falling markets; and
• To reduce the volatility of the overall portfolio.

Before selecting a particular overlay strategy, investors must understand the pay off profile of the overlay, and how the overlay performs under different market scenarios. Options and futures overlays differ significantly in terms of the extent of protection, as well as the flexibility of protection.

Cost is another major differentiating factor when selecting between options-based and futures-based overlay. An option has an initial cost, whilst a futures contract has an opportunity cost.

What is an options overlay?

Specifically, a protective options overlay is a dynamic strategy that aims to reduce the impact of market falls on portfolio value. Strategies that utilise options act much like an insurance policy. The purchaser pays a premium to protect against a potential loss. A portfolio manager can employ different combinations of options to construct a bespoke protective overlay that suits each investment fund’s risk profile.

A put option pay off profile is asymmetric. This is the key difference between options and futures; protecting the downside and preserving the upside at the same time. Below is a simple put option payoff diagram.

In constructing an option portfolio, using either index or single stock options, a portfolio manager can create a payoff profile to suit an investors’ desire for upside participation and downside protection.

What is a futures overlay?

A futures overlay is a protection strategy that aims to reduce the impact of market drawdowns on investor capital.

The most important attribute of a futures strategy is that it has a symmetric payoff profile, as demonstrated in the diagram below.

Being symmetric in nature, it means that futures only offer investors a binary outcome i.e. equal amount of upside and downside risk. This is in contrast to a long options position, where downside risk is limited to the option premium paid, like an insurance policy.

It can be argued that a futures overlay is essentially an asset allocation tool. A futures overlay is managed in either a “risk-on” or “risk off” fashion, where the manager will move away from the risky asset and effectively increase cash exposure by selling futures.

One type of futures overlay acts as a volatility-targeting strategy. In a volatility-targeting strategy, as market volatility rises to around its long run average level, the futures overlay algorithm signals this as stress building in the system and decreases exposure to the market by selling futures. This sell decision will end up being either correct, or incorrect; i.e. if markets fall, the protection decision is correct. However if markets continue to rise, this decision is incorrect and costs any additional portfolio performance that would have been gained.

What is the difference between the overlays?

A futures overlay is a market timing device, while an option overlay is a risk management tool.

There are times where both options and futures overlays work similarly. In falling markets, both strategies will limit the effect of a falling market to varying degrees.

However, the main difference is that options have convexity (i.e. gamma) whereas futures do not. As markets fall, options increase in their effectiveness of cushioning downturns, whereas a futures exposure will remain constant. In a rising market, a put option will become less impactful on a portfolio exposure, such that the portfolio can increasingly participate; a futures contract will retain the effective short weighting. An options overlay will not penalise investors to the same extent for misjudging the market direction. The most investors can lose is the option premium.

Further, a futures overlay should not be treated as a hedge. While the strategy can provide an offset in dislocated markets, on the whole they are non-correlated. A futures overlay also requires a certain amount of time to sell futures. This makes them vulnerable to rapid reversals or the sudden onset of volatility. An options overlay is strongly negatively correlated to the underlying asset. It does not rely on market timing, thereby providing constant, definable protection. It is therefore a better hedge.

Effective exposure

The effective exposure of a portfolio is the amount of the portfolio exposed to the risky asset (in this example the ASX 200).

Below is an example of the differences between the effective exposure of a futures and options overlay strategy between 2008 and 2014. The ASX 200 is the green line and indicates its total return over this time period. The red line shows the option overlay’s effective exposure and the blue line the futures overlay effective exposure with a volatility target.

Negative market: e.g. January 2008 – March 2009: The ASX 200 is falling rapidly. Both futures and options overlay strategies are decreasing their effective exposure as the market falls. The key here is that the effective exposure change of the options is happening organically. That is to say, the delta of the put options is increasing as the market falls. The futures overlay effective exposure is decreasing because the strategy is selling futures. Most of the time the futures strategy is selling low when volatility spikes, and buying high as volatility subsides. Intuitively, this is not the ideal way to enhance portfolio return.

Positive market: e.g. March 2009 – March 2010: The ASX 200 line is moving upwards throughout this period. We can see a volatility targeted futures overlay (blue line) is not as quick to increase its effective exposure.

Flat/Sideways market: e.g. March 2010 – December 2012. The ASX 200 is flat but relatively volatile over the time period. Futures effective exposure (blue line) is more volatile than that of the options overlay (red line). The options strategy is adding more value as the overshoots are less frequent and effective exposure is changing without the buying or selling of assets.

Expected return profile

The chart below outlines the differences between the futures and options strategies against market returns. You can see what the volatility in the futures strategy (blue line) can do to a portfolio’s returns over time – by design it does not participate fully in market rallies. This erodes any positive performance during market declines and tends to limit your portfolio to a market like return over the long run.

In contrast, the options overlay (red line) provides a more stable return on your portfolio, enabling you to lock in the gains achieved in down markets and utilise these in a compounding effect when markets are positive.

Risk adjusted return

The table below shows the options overlay has the highest risk-adjusted return (i.e. information ratio), compared to the futures overlay and ASX 200 with no overlay.

The overall portfolio volatility of the options overlay is slightly higher than the futures overlay, however the return per annum is more than 1.5 times as much, therefore the information ratio is significantly higher than the futures overlay, and is twice that of the ASX 200.

Conclusion

The goal of both options and futures overlay strategies is to protect a portfolio in a falling market. This can be achieved using both approaches. However, we have found that a futures overlay pays for this protection by sacrificing participation in a rally, and long term returns tend to revert to market returns. Further, the futures overlay strategy is not correlated to the market, so its protection is uncertain and cannot safely be considered a hedge.
On the other hand, due to its asymmetric payoff profile and convexity, an options overlay strategy gives investors the ability to add value through active and dynamic hedging. The risk profile over time is improved significantly by reducing the downside volatility, and the upside returns can be preserved.
In conclusion, we believe constructing a protective overlay using liquid, exchange-traded options is the safer and more efficient way to manage portfolio risk.

Dan Bosscher, Portfolio Manager, Perennial Value Management

———-

Disclaimer: Issued by the Investment Manager, Perennial Value Management Limited, ABN 22 090 879 904, AFSL: 247293. Responsible Entity: IOOF Investment Management Limited ABN 53 006 695 021, AFSL: 230524. This promotional statement is provided for information purposes only. Accordingly, reliance should not be placed on this promotional statement as the basis for making an investment, financial or other decision. This promotional statement does not take into account your investment objectives, particular needs or financial situation. While every effort has been made to ensure the information in this promotional statement is accurate; its accuracy, reliability or completeness is not guaranteed. Past performance is not a reliable indicator of future performance.

The post Portfolio Protection – Options versus Futures Overlays appeared first on AdviserVoice.

At Perennial Value, we believe it makes sense to embed risk management in the form of simple insurance style instruments into the equity portfolio itself. The aim is to manage some of the risk of equity market downturns automatically, without the investor having to make a conscious decision to change asset allocations. Using equity derivatives, managing risk in equity portfolios can be more efficient and cost effective, while leaving the upside in markets available to the investor.

Consider a portfolio with a beta approaching 1 on the upside but less than 1 on the downside. As the market rallies, the portfolio also enjoys that rally. As the market falls, the portfolio becomes increasingly weighted towards cash.

Unlike some strategies that give away the upside, we feel managing a portfolio of simple option strategies can achieve the best of both worlds. More importantly managing the downside that is closer to the current level of the share market can give us a better outcome.

We focus on the most likely loss range of a portfolio. To determine the most likely loss range, in the chart below we show six monthly Australian equity returns over a 20 year period. Approximately two thirds of the time, returns are positive and almost one third of the time, returns are negative. Importantly, of these negative returns, 90% of the falls are between zero and -20%.

It makes sense to focus on the capital losses that are most likely to occur. This type of dynamic protection differs significantly in its approach versus many other protected products. Traditional protected products tend to preserve the portion of the portfolio down to zero after the initial fall, sometimes at a very high cost. If you think about this in practical terms, this is the portion least at risk. For example, it is hard to imagine that 100% of the shares in the S&P/ASX200 suddenly all become worthless overnight. As shown in the chart below, dynamic protection focuses on the portion of the portfolio most susceptible to loss, typically in the -5% to -20% range. As markets fall, we adjust the dynamic protection strategies and/or increase cash to protect investor capital.

The other limitation with traditional protected products is that they can end up cashing out in a major market correction, and inevitably when the market does recover, the investor does not get to participate in the upside. We need to avoid this outcome and reset the clock each day, making sure today’s portfolio can meet the needs of the investor.

We buy insurance on our biggest asset, our house, our valuables and car. We even buy insurance on our lives and earnings. But one of our biggest assets, our superannuation, is rarely insured. Why not? Access to option markets can be complex and expensive. This process needs to be managed in an ongoing and professional manner. Option markets provide insurance to the investor. Managing option portfolios historically has been the domain of the investment banking community who design, structure and sell products to do this for us. They can be extremely good investments but they can be complicated, expensive and inflexible for the average investor. The role of the professional investment manager is to navigate this environment such that the portfolio owns the most efficient insurance at any time, maintaining a highly flexible approach compared to most other common strategies.

Derivative instruments can be complex and risky. Intuitively selling insurance is a risky business. Receive a nominal amount and risk an event that could be 20, 30 times more damaging than what you have received. While a derivative portfolio can sell options there is one simple rule to live by: be the net buyer of insurance. i.e. make sure that you own more insurance than you sell. In derivative speak this is called being long ‘vega’.

There are various option strategies that can be used to protect against significant losses. Some of the strategies used include:

Put option – buy put options at a specific strike price to protect the portfolio against falling markets below the strike level.

Put spread – buy put options at a specific strike price while also selling the same number of puts at a lower strike price. A put spread protects the portfolio in falling markets, but to a more limited degree compared to a buying a put option alone, and therefore costs less.

Put spread collar – purchase a put spread while simultaneously selling (writing) an out of the money call option. A put spread collar allows for some upside potential, with less downside risk when there is a decline in the market, for relatively little cost.

Put time spread – buy a put with a shorter-term expiration and simultaneously sell a put with a longer-term expiration. A put time spread allows the portfolio to gain if there is a fall in the market. It is also one of the lowest cost protection strategies used within the dynamic protection portfolio.

The table below shows some examples of the most commonly used protection strategies, what they can achieve on both the downside and upside, and how they compare to each other on a relative cost basis.

By maintaining market participation, and having in place protection strategies that will provide a pay off if the market falls by a specified percentage, capital can be better preserved in the long run.

Dynamic protection can provide peace of mind. If you can limit the downside, investors can feel empowered to stay invested in equities even if markets get choppy, when they might otherwise just panic and exit the market, quite possibly at the wrong time. Limiting capital losses in a market downturn is equally, and possibly even more important, than maximising outperformance in rising markets, due to the effects of compounding. By reducing the impact of a fall in the market on your equity investments, you should have a higher level from which your capital can grow, all thanks to the effects of compounding. Compounding works best if you stay invested. By maintaining market participation, and having protection strategies in place, capital can be better preserved in the long run across varying market conditions.

At Perennial Value, we believe we have moved the goalposts by combining a mainstream long-only Australian equities capability with dynamic protection strategies in the Perennial Value Wealth Defender Australian Shares Trust. By doing this, we have created an investment capability that seeks to limit the drawdown in equity markets while retaining the ability to capture the full upside that equity markets generate over time. In other words, the best of both worlds for those investors who are seeking to protect their equities portfolio from significant capital losses.

———–

Disclaimer: Issued by the Investment Manager, Perennial Value Management Limited, ABN 22 090 879 904, AFSL: 247293. Responsible Entity: IOOF Investment Management Limited ABN 53 006 695 021, AFSL: 230524. This promotional statement is provided for information purposes only. Accordingly, reliance should not be placed on this promotional statement as the basis for making an investment, financial or other decision. This promotional statement does not take into account your investment objectives, particular needs or financial situation. While every effort has been made to ensure the information in this promotional statement is accurate; its accuracy, reliability or completeness is not guaranteed. Past performance is not a reliable indicator of future performance. Investments in the Perennial Value Wealth Defender Australian Shares Trust must be accompanied by an application form attached to the product disclosure statement. The current relevant product disclosure statement and application form can be found on Perennial’s website www.perennial.net.au.

The post Solving the investor’s dilemma – managing volatility in equities (Part 2) appeared first on AdviserVoice.

Equity investors face a constant dilemma: how can I achieve the long term returns that equities can provide, without the capital loss that accompanies market downturns? This question has become particularly pertinent following the GFC and its dramatic impact on share markets. The Australian equity market lost 50% of its value between the peak in November 2007 and March 2009 when the market bottomed.

While most investors appreciate the impact of the loss of capital, they tend to overlook the secondary impact; they now earn future returns on a reduced amount of capital. Over time this can have a significant impact on investment outcomes.

Risk management in client investment portfolios has traditionally been an asset allocation decision. Indeed, for an overall “balanced” portfolio asset allocation may work to an extent, cushioning portfolio volatility through diversification. But why wouldn’t you seek to manage volatility within an equity portfolio?

Most long only managers are employed to generate ‘alpha’ above an equities benchmark. ‘Beta’, the risk arising from exposure to general market movements, is someone else’s concern (typically the asset allocator putting together the investor’s portfolio). Why then was the average investor unhappy when their equity fund halved in value in 2008? After all, their manager had a mandate to be at least 90% invested in equities, regardless of how bearish they may have been. The simple answer is that conventional equity products do not meet all investors’ expectations during such difficult times.

Numerous studies have shown that the pain of losing money is greater than the joy of making it. But emotions aside, the loss of capital is a serious matter. In our view ‘risk’ is the probability of losing money, not just volatility. It took almost six years for the market to return to its November 2007 high on an accumulation basis. If you had invested at the pre-crisis peak, this equates to a 100% return – a return that only gets you back to where you started.

This dilemma is most important for those investors approaching retirement. For these investors the possibility of loss can pose a more significant problem. The issues arise where the pattern of equity market returns is such that large negative returns occur early in the drawdown phase causing investors to eat into their capital such that they do not get the full benefit when markets inevitably rebound. This is known as ‘sequencing risk’. Given that we are in retirement for longer, we need to make sure that when we do retire our asset base is as healthy as it can possibly be.  What that means is that as we approach retirement age we need to be even more mindful of losing capital. Hence, while risk management is always important, it is even more important in the pre-retirement phase and in the early years of retirement.

One common solution proposed to reduce the impact of negative market movements in the retirement phase is to adjust the asset allocation mix by decreasing the allocation to growth assets and increasing the allocation to defensive assets. But will a portfolio skewed towards fixed interest assets be able to deliver the growth required to sustain a long and comfortable retirement? Does trying to solve the issue of sequencing risk in this manner just open up a new risk – longevity risk? That is, the risk that you will outlive your nest egg. With life expectancies growing and the cost of living rising, more than ever our retirement nest egg needs to be maximised, both at the start of retirement and throughout the drawdown phase. Therefore reducing exposure to growth assets may not be the solution.

Alternatively, some investors believe that timing is the solution to protecting their capital in market downturns. “I will just pull my money out of shares and put it into cash, then put it back into shares when the market turns”, right? Wrong. Perfect timing is impossible to achieve without the benefit of hindsight.

The chart below shows the impact that timing can have on returns. Consider $1,000 invested in the Australian share market over 30 years (left hand bar). By staying invested over the whole 30 years the investment would have grown to be worth almost $23,000 (after tax at the highest marginal rate) or an 11.0% p.a. return. At the other extreme (right hand bar), consider a situation where with perfect hindsight, moving in and out of the market at exactly the right time (which of course is all but impossible to do) would have produced more than $260,000 (equivalent to a 20.4% p.a. return); over 10 times the dollar amount achieved by just staying invested in the market over the 30 years. While perfect timing is unrealistic, it does illustrate that there is a significant opportunity to improve our long term returns if we as investors can better manage the risk of losing capital during periods of significant market downturn. The key is to try and stay invested, but find alternative ways to reduce your effective exposure when needed in a market downturn.

In the example below, the opportunity set that arises by better managing the capital risk of your portfolio lies between $23,000 and $262,000. It is within this opportunity set that we believe dynamic protection can help enhance returns.

An important point here is that timing affects your market participation, and you need to maintain good market participation in order to maximise future returns. But attempting to time the market is very challenging. It is neither a rational or likely achievable strategy. Risk management can produce a better and smoother outcome for investors, in our view.

Managing the downside in equity portfolios can be the difference between staying in front, and falling behind, perhaps forever. We believe the best of both worlds is to have a risk management strategy that allows investors to benefit from the superior long term return of shares, while having a dynamic protection strategy in place to help reduce the impact of market drawdowns.

At Perennial Value, we believe risk should be managed both within equity funds as well as via asset allocation changes. In some cases, particularly for retirees, it makes sense to embed risk management in the form of simple insurance style instruments into the equity portfolio itself. The aim is to manage the risk of equity market downturns automatically, without the investor having to make a conscious decision to change asset allocations.

In part two of this article we will discuss the strategies utilised that make it possible to embed risk management within an equity portfolio and how this can provide investors with a degree of confidence to remain invested in equities, regardless of market volatility or their proximity to retirement.

————————

Disclaimer: Issued by the Investment Manager, Perennial Value Management Limited, ABN 22 090 879 904, AFSL: 247293. Responsible Entity: IOOF Investment Management Limited ABN 53 006 695 021, AFSL: 230524. This promotional statement is provided for information purposes only. Accordingly, reliance should not be placed on this promotional statement as the basis for making an investment, financial or other decision. This promotional statement does not take into account your investment objectives, particular needs or financial situation. While every effort has been made to ensure the information in this promotional statement is accurate; its accuracy, reliability or completeness is not guaranteed. Past performance is not a reliable indicator of future performance.

The post Solving the investor’s dilemma – managing volatility in equities (Part 1) appeared first on AdviserVoice.

The product seeks to dynamically safeguard investors against large downside losses while allowing for full participation in domestic equity market gains. It provides investors with a bottom-up, Australian equities portfolio comprised of large and small cap listed companies and uses equity derivatives and cash to dynamically protect the portfolio through market cycles, thereby reducing the magnitude of significant negative returns as they occur.

Called the Perennial Value Wealth Defender Australian Shares Trust, the fund was launched by Perennial Value Management Limited (Perennial Value) in late May 2014. It has subsequently secured a Recommended rating from independent investment research firm Zenith Investment Partners.

Head of Retail Funds Management for Perennial, Brian Thomas said the Zenith rating was a welcome independent validation for the fund. The fund has also resonated strongly with financial advisers in the days since its retail launch.

“The stark reality we all faced during the GFC was that a 50% fall in our share values required a 100% future return to get back to pre GFC levels, and investors are expecting further volatility in the future. According to recent Investment Trends research, 91% of financial advisers are expecting two or more market crashes in the next 20 years and the investors we speak to have similar outlooks, ” Mr Thomas said.

“We believe Perennial Value has created an innovative product that is purpose built for the needs of investors and it brings a unique and dynamic approach to managing downside risk.”

“The fund’s unique design and underlying protection process is unlike anything available to Australian retail investors to date,” he said. Mr Thomas said Perennial Value’s considerable investment management expertise (led by renowned value investor John Murray) coupled with its dynamic portfolio protection strategies adds a new dimension to the management of market volatility on behalf of investors. The fund’s dynamic portfolio protection strategies are managed by Perennial Value’s Dan Bosscher.

Zenith’s report said the fund: “…provides investors with a unique exposure to Australian equities which is intuitively appealing. Through the use of dynamic protection strategies, the fund aims to create an asymmetric return/risk profile that is designed to reduce losses in market downturns by approximately 50 per cent whilst allowing for full participation in market upswings. Zenith believes the fund is an innovative product managed by a highly capable risk expert in Dan Bosscher.”

The post Perennial Value Wealth Defender gains independent validation as advisers stay wary of equity market volatilty appeared first on AdviserVoice.