Michael Armitage

Milliman’s new model portfolio strategy allows dealer groups and platforms to apply a rules-based market risk management overlay to any model portfolio’s underlying equity investments.

It marks the first time that model portfolio investment teams and financial advisers will be able to manage equity risk on behalf of retirees and other risk-averse clients while also retaining control of equity investments, whether direct shares, managed funds or ETFs.

Milliman’s Director of Investment Services, Michael Armitage said the innovative structure can be used in several ways, including to develop ‘white labelled’ solutions.

“Milliman’s model portfolio solution meets the needs of investors such as retirees who cannot endure sustained market drawdowns that often occur with equity investments. It also allows model portfolio investment teams to extend their asset allocation capabilities with bespoke, risk-managed solutions across their accumulation and retirement models.

“Milliman has partnered with some of the world’s largest financial firms since the 1990s to deliver similar retirement solutions and this new service now offers an alternative access point for the Australian market.”

Fortnum Financial Advisers is the first firm to employ the solution. It has applied it across the full range of Innova model portfolios available via the HUB24 platform from September 2017.

“This is the first time investors can access a world-class risk management strategy, easily applied to the same wide range of model portfolios they currently use,” said Milliman’s Australian practice leader Wade Matterson.

“The flexibility of the Milliman model portfolio solution will revolutionise the ability of dealer groups and their advisers to provide efficient retirement solutions that are directly aligned with individual clients’ goals.”

Milliman’s model portfolio solutions offer retail investors a more flexible, lower-risk option that uses the same asset protection techniques that Milliman has applied on behalf of clients around the world for over 20 years.

As a retirement specialist focused on sequencing risk and retirement outcomes, Milliman continues to work with leading firms in Australia including Maritime Super, BetaShares, Colonial First State, Pengana Capital and Plato Investment Management.

Milliman’s model portfolio strategy is accessed through an allocation to unit trusts tailored specifically to the underlying model portfolios allocations. The strategy can be applied to any model portfolio structure (including platforms and managed discretionary accounts) and is equally effective against any type of equity holding (including managed funds and direct shares).

The allocations to the risk management unit trusts also allows the strategy to be switched on or off at any time, allowing advisers to make adjustments in response to market conditions or client goals, without having to invest in an entirely different model portfolio. Risk management is particularly important for older investors or retirees given the heightened sequencing risk they face, combined with the need to remain invested in growth assets to help fund longevity of savings through an expected two decades in retirement.

However, risk management is also important to all investors. The recent ASX 2017 Investor Survey found that the majority of Australians are risk averse by global standards, seeking stable and reliable or guaranteed returns:

• 81% of investors under 35 are seeking guaranteed or stable investment returns
• 21% of the most risk averse investors expect returns over 10%
• 41% of investors over 55 are comfortable with some variability in their returns.

The Milliman model portfolio solution utilises Perpetual RE services and Lonsec has approved the unit trusts in their initial August review, noting that fees are more transparent and reasonably priced than most other option-related capital protected products it has reviewed.

“The product overcomes some of the shortcomings of earlier capital protection techniques, some of which became ‘cash-locked’ during severe equity market downturns and investors were unable to participate in any subsequent equity market recovery,” the Lonsec report said.

“Lonsec considers this to be a key feature of the product. Investors are also afforded significant flexibility, with the ability ‘switch on’ and ‘switch off’ risk management overlay at any time.”

Milliman Financial Risk Management (Milliman FRM), which employs over 150 professionals in Chicago, London, and Sydney, provided advisory, hedging, and consulting services across $152 billion in global assets as of June 30, 2017.

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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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No fund ratings have changed for managers returning from the previous year’s sector review. The peer groups cover funds-of-hedge-funds and multiple strategy single-manager offerings.

S&P Fund Services analyst, Michael Armitage said: “Fund performances over 12 months to December 2011 were mixed depending upon a strategy’s equity market correlation. Strategies with more long equity market exposure exhibited positive performance in the fourth quarter of 2011 in line with general equity market performance”. 

Generally, funds-of-hedge-fund indices experienced slightly negative to flat performance over the course of 2011—which was a difficult environment for many alternative styles. Several managers outperformed in these conditions, including Dexia Alpha Dynamic and HFA International Shares funds.” 

“The stability shown in our ratings underscores our previous conviction in the peer group offerings. Major themes of this year’s review continue to focus upon liquidity of underlying holdings and ‘truer’ alternative return profile strategies in fund-of-fund portfolios,” said Mr Armitage.

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“The report shows that managed futures trading strategies continue to show diversification benefits for investor’s portfolios, while assets under management within the industry reached new peaks,” said Michael Armitage, analyst at S&P Fund Services. 

“However, an increase in funds under management, which notably amassed within the largest managed futures products, increased our focus on potential capacity issues,” Mr Armitage said. 

Relative value and directional macro investing were found to present significantly different return profiles, which investors and advisers should understand. While both types of strategies will present variable correlation to traditional investments, directional global macro typically exhibits strong positive skewness of returns, and the ability to perform strongly in dislocated markets. Conversely, relative value strategies have historically been challenged in periods of extreme market duress. 

Reports for all funds rated as part of this sector review are available on S&P’s subscriber website www.fundinsights.com. A copy of the sector report can be made available to media representatives upon request.

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The product is designed to mitigate historical issues of investing within FOHFs. Namely, to provide investors improved liquidity, diversification, transparency, and reduced overall fees.

In our view, the New York-based alternative investment specialist RASL provides local investors with an experienced institutional-quality manager able to deliver on the investment objectives of the offering through efficient access to a diversified portfolio of alternative investments.

“Advance and RASL have combined to offer Australian investors a more efficient access to alternative multi-strategy investing while maintaining the diversification benefits of investing within alternative investments. Through the use of ‘alpha managers’, alternative beta replication, managed accounts, rules-based ‘algorithmic’ strategies, and hedging overlays, the offering seeks more efficient access to a given strategy for liquidity, cost, transparency, and performance,” said S&P alternatives sector head Michael Armitage.

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The product is primarily a fundamental strategy seeking equity market exposure to companies in the Asia-Pacific region, with a historical concentration in China and Hong Kong shares.  

In our view, Pengana is a fundamentally focused long/short equity manager seeking to provide intelligent equity market exposure that incorporates global macro and currency assessment and minimises drawdown through reducing beta exposure during negative market environments. 

“We see the strength of the team is in their demonstrated understanding of multiple factors that drive equity returns in the region including China government policy, investor sentiment, and global macro risks,” said S&P Fund Services sector head Michael Armitage. 

Historically, the manager has exhibited low correlation with Asia-Pacific equity market indices providing diversification benefits for investors. 

Over an investment cycle of five or more years, we would expect the manager to outperform and deliver returns with lower volatility of the relevant index.

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S&P Fund Services’ alternative strategies sector head, Michael Armitage said: “Most of the alternative equity peer groups have shown risk-adjusted returns that are superior to their long-only indices. Given continued uncertainty and increased levels of volatility, investors will benefit from managers that have more unconstrained strategies—especially those that also concentrate on capital preservation. Additionally, we continue to witness stronger institutional quality offerings, which increased the overall level of competition in our peer review.” 

The report covers the release of 38 alternative equity capabilities in equity beta variable, alternative income, market-neutral, and market exposure strategies as part of S&P’s latest review of the sector. One manager received a downgrade, three managers received upgrades, and with five new ratings (three of which were four stars), the peer group is relatively stable since our previous Alternative Equities review in 2010. 

“With global equity markets experiencing significant effects of global macro events in recent periods and the classic “buy and hold” equity proposition failing many investors over extended periods, alternative equity strategies continue to present a strong case for inclusion in a well-diversified portfolio. Market exposure strategies continue to present mixed returns with fundamentally driven strategies outperforming quantitative-based strategies. In addition, market-neutral strategies have impressed and offer further diversification for investors,” said Mr Armitage. 

Some of the key findings from the sector review: 

• Investors were cushioned on the down side with help from the flexible mandates of the variable beta peer group managers that are continuing to show their strengths since our last review.
• The equity income sub-peer group impresses us as a product that is underappreciated as a potential core allocation for income-focused investors.
• The three market-neutral trading strategies proved their worth as “alternatives”—showing alpha and avoiding significant drawdowns in negative equity environments—demonstrating effectively the portfolio diversification potential of the format.
• Teams and processes with multiple sources of alpha generation continued to score higher relative to peer funds (despite the fact that some may have shown poor performance contribution from one or more of these particular sources over the period since our last review, e.g. active currency positioning).
• Incremental improvement of risk-management staffing, protocols, and systems at certain firms has raised the bar for the sector as a whole, in our view.
• Manager trading ability and understanding of the particular risks of short-selling—and how they might be mitigated—remains mixed.

In what is a continuing point of focus for us, we note that managers are mostly showing good awareness of the credit risks inherent in shorting, fund custody, and prime brokerage arrangements. However, these continue to be addressed only slowly, and not by all.

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