Even before things went sour in the financial markets, individuals were having to take on more responsibility for planning and funding their own retirements.
The decline of defined benefit (DB) pensions over the past two decades—and corresponding rise in 401(k)-type retirement savings programs—has been accompanied by an explosion of financial planners, planning tools, and products, all aimed at helping individual investors navigate an increasingly complex financial marketplace.
Ken Mungan, Ghalid Bagus, and Matt Zimmerman, from Milliman’s Financial Risk Management practice, discuss new approaches to risk management that help overcome challenges for portfolio protection in the post-global financial crisis environment.
Risk management based on asset diversification has been central to these innovations.
However, as the authors point out, traditional asset diversification failed to mitigate the effects of a financial marketplace where most asset classes declined simultaneously. Clearly, financial advisors need new risk management protection strategies that “involve assembling and managing a portfolio of hedge assets tailored to each client’s investments.”
Such an approach seeks to counteract the natural tendency of the average investor to buy high, when the market is strong, and to sell low, after significant market decline, which, of course, plays havoc with investment returns.
The authors detail a strategy that reduces risk and enhances the overall value of an investment portfolio by locking in gains from underlying investments and harvesting gains from the hedge portfolio during severe market corrections.