Tag Archives: FRM

Milliman FRM Market Commentary: May 2017

Stocks are seemingly indefatigable, marking their seventh consecutive month of positive returns. In this month’s commentary we address:

• Equity market volatility exhibits an inverse relationship with stock/bond correlation. This is a benefit to managed risk funds.
• As a result of ongoing low volatility, managed risk funds have generally implemented their respective maximum equity allocations for most of 2017.
• Market-based measures of financial risks are near precrisis lows. How does a managed risk approach fit in that context?

To learn more, read Joe Becker‘s full commentary at MRIC.com.

Goal tolerance: When goals meet risk tolerance

There are clear reasons why risk tolerance drives the financial advice process. It produces a simple number, which makes it relatively easy to recommend investment products while maintaining a compliant paper trail. But such a heavy reliance on risk tolerance can also produce significant problems.

Risk tolerance is too often thought of as an unchangeable number even though there is little academic guidance on the most effective way to measure it, leading to widely varying estimates (and subsequently portfolios) between advisers.

Placing a greater emphasis on clients’ objectives and wrapping this around their risk tolerance can produce higher levels of engagement and offers a more accurate pointer to investor behaviour. Milliman’s Wade Matterson and Craig McCulloch offer some perspective in this article.

Super funds need a balanced view of investment returns and risk

Lower investment return targets on top of higher investment risk can create disengaged investors in Australia’s superannuation industry. In this article, Milliman’s Michael Armitage offers perspective on how super funds can “pursue more innovative strategies to match risk and return to suit different groups” to meet the needs of individual investors.

Here’s an excerpt:

Older members and those with larger balances, who are more sensitive to risk (both volatility and maximum drawdown), need special attention.

Rather than automatically reduce investment return targets or increase investment risk, some funds are exploring alternative options beyond 70:30 style default funds. No single approach is perfect, but whatever strategies are chosen, they should ultimately increase the probability that members meet real (not assumed) goals.

The Future Fund may be a unique example (no members and no inflows), but it has taken a far more absolute return approach than typical super funds–even with the knowledge that government could start drawing down funds from 2020. Similarly, some super funds are taking a greater risk parity approach (that goes deeper than simply gearing up bonds) by focusing on the amount of risk in each portfolio allocation rather than the specific dollar amounts invested.

Maritime Super has also recognised the role of risk–last year, it applied a futures-based risk overlay (managed by Milliman) aimed at controlling extreme volatility and limiting capital losses to its default MySuper option. Its membership is older and has higher value balances than many other industry funds.

Other funds are now using futures to tilt their portfolio allocations based on relative valuations over the short term. This type of implementation management can potentially better manage risk and marginally improve returns.

These are just some of the innovations currently taking place as funds differentiate themselves and leave herding behaviour behind.

Is a comfortable retirement possible in the superannuation world?

The ASFA Retirement Standard states that an average Australian couple requires about A$640,000 in their superannuation fund at retirement (or AUD 545,000 for a single person) to live comfortably. According to Milliman’s Jeff Gebler and Wade Matterson, “The personalised nature of each superannuation member’s retirement journey means a one-size-fits-all approach simply cannot deliver the necessary information, products, and risk management strategies required to achieve everyone’s desired outcomes.”

In the article “Why the industry’s ‘comfortable retirement’ measures are wrong,” Gebler and Matterson discuss the need for enhanced benchmarks based on available data and communication strategies to deliver better financial outcomes that individuals can live with comfortably.

How did financial markets respond to Brexit?

Throughout the month of June leading up to the Brexit vote, the markets appeared to have trouble deciding which way the vote would go. Equity markets began to sell off during the second week of June as Brexit appeared to be increasingly likely. On June 14, as sentiment changed and the likelihood of Brexit seemed to be waning, equity markets started to climb back to early June levels. Markets were firmly higher on the day of the vote, exhibiting confidence that Britons would choose to stay in the European Union. As vote counts came in, currency and futures markets grew increasingly volatile with the rising prospect that Brexit would prevail. The next morning, equity markets opened sharply lower, displaying the characteristics of a classic gap event. Milliman consultants Adam Schenck,  Jeff Greco, and Joe Becker provide more perspective in this article.

Changing public pension investment landscape

The global financial crisis shrunk the funding status of many public pensions. Some sponsors are beginning to cut their expected rate of return, and change the way they invest and handle portfolio risk. In this Reuters article, Milliman consultant Tamara Burden provides perspective on how sponsors can better manage their pension investment risk.

The growing recognition that short-term volatility can have a devastating impact on mature pension plans in the $4 trillion sector could herald a sea change in the way public funds invest in the future.

“There is this shift to recognizing risk is a relevant piece of the discussion, it’s not just about how you get the highest returns over a long period of time but that short-term fluctuations in asset levels can be incredibly detrimental,” said Tamara Burden, an actuary at consulting firm Milliman….

Burden is seeking to persuade public pension managers to use Milliman’s risk management strategy to reduce equity exposure in portfolios by shorting stock index futures. This means they don’t have to sell their fund’s equity holdings.

The strategy is being applied to about $70 billion in portfolios with variable annuities, retail mutual funds and collective investment trusts used by 401(k) plans, but so far not in the public pension sector.

Interest, Burden says, has increased this year with about 15 public pension administrators considering a shift versus five during the same period last year.