Home / Wide-angle lens approach to managing volatility

(pictured: Thomas Lee) 

Smoothing the journey to retirement through various defensive strategies has generally been assumed to cost the member in terms of the end outcome. A paper by Parametric Portfolio Associates shows that this outcome, or ‘destination’, can also be enhanced in a defensive strategy.

Parametric has published a paper that argues that it is possible to reduce volatility in an equities portfolio while continuing to grow retirement savings. The strategy involves de-risking an equities index, such as the S&P/ASX 200, while writing an options overlay which generates an additional and stable well-priced return stream.

The paper was written by Thomas Lee, managing director of investment strategy and research at the Minneapolis Investment Center at Parametric and Raewyn Williams, the Sydney-based director of research and after-tax solutions. They say concerns about the impact of volatility have been elevated by things such as fund portability, short-term performance reporting and demographics surrounding retirement. But solutions exist by taking advantage of the volatility risk premium.

On a visit to Australia last week, Thomas Lee said that the firm’s ‘Defensive Equity’ strategy could add 50bps or more to a portfolio which had been partially de-risked through adding 50 per cent in sovereign bills to an equity index. Parametric is currently running about US$4 billion in the strategy in the US and more against the MSCI ACWI index.

“We [Parametric] are known for providing meaningful outperformance through efficient strategies,” he said. “No-one’s afraid of upside volatility. We can structure the de-risking to capture some of the volatility premium too.”

Raewyn Williams said the three standard responses to the volatility issue in retirement are each deficient in some way. They are:

• taking the ‘edge’ off the portfolio through some factor-based defensive strategy which still leaves a fairly ‘rocky path’
• de-risking through changing asset allocation, which results in a trade-off of member returns for a smoother path, and
• buying some kind of protection, or volatility dampening, which tends to be expensive.

“We think that there is a better way to smooth the path [of returns] without giving away so much,” she said.

The paper says: “As funds rise to the challenge of managing volatility, we ask them to take a ‘wide-angle lens’ view of the problem. It is not only the journey, but also the destination that counts for members.”