Despite being a growing reservoir of funds under management, this critically important pool of capital is confronting mounting problems collating and disseminating key data in a timely manner.
The ratings house is pinning its growth strategy on a revamped methodology that increases the emphasis on governance to 25 per cent – a timely move considering APRA’s proposed reforms.
Frontier steps up campaign on portfolio protection
Frontier Advisors has suggested its clients, mainly big super funds, include hedge funds in their consideration of portfolio insurance options, widening a brief that the consulting firm started early last year. This follows a ‘normalised’ value for the Aussie dollar and continued low level of sovereign bond yields.
The asset-consulting firm says in its second quarterly report on alternatives and innovation, known as ‘Alt IQ’, that it has been reviewing whether there is a way to use hedge funds solely as a defensive asset, to proxy the role traditionally played by sovereign bonds and foreign currency exposure in a balanced portfolio.
Early last year, Frontier recommended that funds should consider put options over their listed equities as a form of portfolio insurance. The firm has recognized that a put option overlay is not practical for all clients and that some may prefer a funded strategy instead or in addition to.
The two new strategies suggested are: ‘funded tail-risk’ strategies; and, ‘long-volatility’ strategies. Both tend to benefit from a move from low-to-high volatility, which generally occurs when equity markets fall.
Unlike a simple passive approach to put options, the hedge fund managers using these strategies will look to actively manage the portfolio in a ‘left-tail’ event, by taking profits and rotating to new contracts. The long-volatility strategies are designed to kick in earlier than tail-risk hedging strategies but will not deliver as significantly outsized returns in an event such as the 2008 financial crisis would deliver for them both.
Frontier says: “Both strategies will likely exhibit basis risk, given the underlying instruments used are not perfectly matched to the portfolio exposure being hedged (unlike a simple equity put option overlay strategy).
“A key area of focus for both strategies is the need to manage the ‘time decay’. [This] is the reduction in the value of the underlying instruments (typically options) as the chance of a future payoff diminishes as time passes – the closer the option is to expiry, the smaller the chance of a significant equity market fall and the lower the value of the option.”
Frontier notes that these strategies are unlikely to represent a long-term allocation in a well-diversified portfolio primarily because of the time-decay factor.
“However, for portfolios that are currently less ‘balanced’, we believe long-volatility and tail-risk hedging funds, for investors without direct tail-risk hedging in place, are worth further investigation.”
