Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
How a couple of tweaks can help retirees in equities
Even a passive portfolio consisting entirely of Aussie equities can provide some of the defensive and yield-bearing characteristics that retirees usually need with a couple of smart-beta-type tilts.
The latest short research note from Parametric, the implementation-focused manager, examines what such a strategy, which it calls ‘Keep Calm and Carry On Investing’ would have done for retirees or other with similar risk appetites during last year’s market collapse.
Written by Raewyn Williams and Josh McKenzie in the Sydney office – before Raewyn retired from her position last month – the note compares the popular S&P/ASX 200 market-cap index performance during March last year, with a portfolio with smart-beta tilts towards low volatility and dividend-yielding stocks and a program of listed index options writing out-of-the-money calls.
While both portfolios lost money in the record-breaking drop of 20 per cent in the Aussie market in just 14 days, the “Keep Calm’ portfolio was 80bps ahead of the plain-vanilla index. Most of the excess came from the low-volatility tilt, with some also from the options writing. The dividend-yield tilt actually subtracted value in that period.
Williams and McKenzie point out, however, that dividend yields were primarily brought into the exercise because of the common desire by retirees to want regular income to replace, at least partially, the wages and salaries they no longer draw. These stocks did, indeed, do that. They added 25bps in excess dividend yield, after taking account of franking credits.
They said: “We see, overall, how the various components of our ‘Keep Calm and Carry On’ investing retirement equities solution would have operated to give a better experience to a super fund’s pension members than an index-tracking accumulation portfolio through the tumultuous onset of COVID-19 this time last year.
“It should remind super funds, as they design and build out their pension solutions, that equity objectives need to align with the unique problems faced by this member cohort.”
Given the implementation of the CIPR (Comprehensive Income Products for Retirement) regulation from July next year, now alongside the delayed Retirement Income Covenant, retirement strategies are bound to be integrated into many super fund options in the future; not just specific pension products.
As the Parametric note demonstrates, sudden market falls can also be very sharp and anyone who is only a few months away from taking a lump sum can be severely impacted.
