Managed Risk Alternatives for V-Shaped Markets. Chris Onken, FSA, MAAA

Transcription

1 Managed Risk Alternatives for V-Shaped Markets Chris Onken, FSA, MAAA

2 Managed Risk Alternatives for V-Shaped Markets CHRIS ONKEN, FSA, MAAA Consulting Actuary, Milliman November 15, 2016 ( hours)

3 Important Disclosures The information, products, or services described or referenced herein are intended to be for informational purposes only. This material is not intended to be a recommendation, offer, solicitation or advertisement to buy or sell any securities, securities related product or service, or investment strategy, nor is it intended to be to be relied upon as a forecast, research or investment advice. The products or services described or referenced herein may not be suitable or appropriate for the recipient. Many of the products and services described or referenced herein involve significant risks, and the recipient should not make any decision or enter into any transaction unless the recipient has fully understood all such risks and has independently determined that such decisions or transactions are appropriate for the recipient. Investment involves risks. Any discussion of risks contained herein with respect to any product or service should not be considered to be a disclosure of all risks or a complete discussion of the risks involved. Investing in foreign securities is subject to greater risks including: currency fluctuation, economic conditions, and different governmental and accounting standards. There are risks associated with futures contracts. Futures contract positions may not provide an effective hedge because changes in futures contract prices may not track those of the securities they are intended to hedge. Futures create leverage, which can magnify the potential for gain or loss and, therefore, amplify the effects of market, which can significantly impact performance. There are also risks associated with investing in fixed income securities, including interest rate risk, and credit risk. The recipient should not construe any of the material contained herein as investment, hedging, trading, legal, regulatory, tax, accounting or other advice. The recipient should not act on any information in this document without consulting its investment, hedging, trading, legal, regulatory, tax, accounting and other advisors. Information herein has been obtained from sources we believe to be reliable but neither Milliman Financial Risk Management LLC ( Milliman FRM ) nor its parents, subsidiaries or affiliates warrant its completeness or accuracy. No responsibility can be accepted for errors of facts obtained from third parties. Past performance is not indicative of future results. Index performance information is for illustrative purposes only, does not represent the performance of any actual investment or portfolio, and should not be viewed as a recommendation to buy/sell. It is not possible to invest directly in an index. Any hypothetical, backtested data illustrated herein is for illustrative purposes only, and is not representative of any investment or product. RESULTS BASED ON SIMULATED OR HYPOTHETICAL PERFORMANCE RESULTS HAVE CERTAIN INHERENT LIMITATIONS. UNLIKE THE RESULTS SHOWN IN AN ACTUAL PERFORMANCE RECORD, THESE RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, BECAUSE THESE TRADES HAVE NOT ACTUALLY BEEN EXECUTED, THESE RESULTS MAY HAVE UNDER-OR OVER-COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED OR HYPOTHETICAL TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THESE BEING SHOWN. For any hypothetical simulations illustrated, Milliman FRM does not manage, control or influence the investment decisions in the underlying account. The underlying accounts in hypothetical simulations use historically reported returns of widely known indices. In certain cases where live index history is unavailable, the index methodology provided by the index may be used to extend return history. To the extent the index providers have included fees and expenses in their returns, this information will be reflected in the hypothetical performance. Milliman FRM does not intend the use of such indices to be construed as investment advice or a recommendation to invest in similar accounts. The materials in this document represent the opinion of the authors at the time of authorship; they may change, and are not representative of the views of Milliman FRM or its parents, subsidiaries, or affiliates. Milliman FRM does not certify the information, nor does it guarantee the accuracy and completeness of such information. Use of such information is voluntary and should not be relied upon unless an independent review of its accuracy and completeness has been performed. Materials may not be reproduced without the express consent of Milliman FRM. Milliman Financial Risk Management LLC is an SEC-registered investment advisor and subsidiary of Milliman, Inc. 2

4 Important Disclosures The launch date of the S&P Managed Risk Index Series was April 11, The launch date of the S&P 500 was March 4, The launch date of the S&P 400 was June 19, The launch date of the S&P 600 was October 28, The launch date of the S&P 400 was June 19, 1991.All information presented prior to the index launch date is back-tested. Back-tested performance is not actual performance, but is hypothetical. The back-test calculations are based on the same methodology that was in effect when the index was officially launched. Past performance is not a guarantee of future results. Please see the Performance Disclosure at for more information regarding the inherent limitations associated with back-tested performance S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. Redistribution, reproduction and/or photocopying in whole or in part are prohibited without written permission. Standard & Poor s, S&P, S&P High Yield Dividend Aristocrats, S&P 500, S&P MidCap 400, S&P SmallCap 600, S&P 100, S&P Composite 1500, Dividend Aristocrats and S&P Europe 350 are registered trademarks of Standard & Poor s Financial Services LLC ( S&P ), a division of S&P Global. S&P 500 Low Volatility Index is a trademark of Standard & Poor s Financial Services LLC ( S&P ), a subsidiary of McGraw Hill Financial, Inc. Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC ( Dow Jones ). Dow Jones U.S. Select Dividend, Dow Jones EPAC Select Dividend, Dow Jones Global Select Dividend, Dow Jones Industrial Average, and Dow Jones Transportation Average are trademarks of Dow Jones Trademark Holdings LLC ( Dow Jones ). S&P Dow Jones Indices LLC, Dow Jones, S&P and their respective affiliates ( S&P Dow Jones Indices ) makes no representation or warranty, express or implied, as to the ability of any index to accurately represent the asset class or market sector that it purports to represent and S&P Dow Jones Indices shall have no liability for any errors, omissions, or interruptions of any index or the data included therein. Past performance of an index is not an indication of future results. This document does not constitute an offer of any services. All information provided by S&P Dow Jones Indices is general in nature and not tailored to the needs of any person, entity or group of persons. S&P Dow Jones Indices receives compensation in connection with licensing its indices to third parties. It is not possible to invest directly in an index. Exposure to an asset class represented by an index is available through investable instruments offered by third parties that are based on that index. S&P Dow Jones Indices does not sponsor, endorse, sell, promote or manage any investment fund or other investment vehicle that seeks to provide an investment return based on the performance of any Index. S&P Dow Jones Indices LLC is not an investment advisor, and S&P Dow Jones Indices makes no representation regarding the advisability of investing in any such investment fund or other investment vehicle. This represents a complete list of all exchange traded products linked to the indices noted above as of September 30, While we have tried to include all exchange traded products, we do not guarantee the completeness of such list. SPDJI does not sponsor, promote or sell any product linked to our indices. For situations where only one product is listed for an index, based on our analysis this was the only product currently linked to such index. SPDJI does not recommend or provide any advice regarding such product. 3

5 Market Environment

6 Product Goals Consumer Needs I want to get the same income, no matter what happens to the stock market I want my income to keep up with inflation Retirement Risks Volatility Sequencing Inflation Methods to Address Risks Target volatility Capital protection delivers cash payoffs for hedging Risk overlay gives confidence to invest in equities I don t want to run out of money Longevity Addressing sequencing and under-investing risk helps maintain the value of the fund I want to be able to get my money out whenever I need it Flexibility Invest in simple assets: futures, cash or underlying assets only Proprietary & Confidential 5

7 Evolution of Risk Management Strategies Not Hedged Simple Strategies Full Risk Transfer Sophisticated Risk Management Programs Incorporate Risk Management in Product and Fund Design No risk management Put options Static solutions Reinsurance Dynamic hedging Sufficient protection with less hedging 6

8 Relationship of Return to Volatility S&P 500 Index, Source: Milliman Financial Risk Management LLC, The performance data represents past performance, is for illustrative purposes and is not intended to represent any actual investments. Past performance is no guarantee of future results. The S&P 500 Index, is a commonly used benchmark comprised of all the stocks in the S&P 500 weighted by market value. Indexes are unmanaged. It is not possible to invest directly in an index. This graph analyzes the total returns of the S&P 500 index. Each day is assigned a volatility measure that is equal to the volatility of the 21-day period surrounding that day s return. The returns are then assigned to a category of low, medium or high based on whether the volatility is <10%, 10-30%, or >30% respectively. Finally, the return that is graphed is the average of the daily returns assigned to each category, annualized. The volatility that is graphed is the average of the annualized 20-day volatilities associated with the returns assigned to each category. 7

9 Risk & Return Quadrants for S&P 500 Index Low Vol, Rising High Vol, Rising 67% 18% Low Vol, Rising High Vol, Rising 70% 29% 2015 Low Vol, Rising High Vol, Rising 0% 59% Low Vol, Falling 7% High Vol, Falling 8% Low Vol, Falling 1% High Vol, Falling 0% Low Vol, Falling 41% High Vol, Falling 0% Proprietary & Confidential 8

10 Recent Volatility and Returns High Vol Down Market Low Vol Up Market High Vol Down Market High Vol Recovery Volatile Vol Up Market Average # of days for post-spike volatility reversion Before 2012 Since Source: Bloomberg, 1/01 12/15. Past performance is not indicative of future results. Index performance information is for illustrative purposes only, does not represent the performance of any actual investment or portfolio, and should not be viewed as a recommendation to buy/sell. It is not possible to invest directly in an index. Any hypothetical, backtested data illustrated herein is for illustrative purposes only, and is not representative of any investment or product. RESULTS BASED ON SIMULATED OR HYPOTHETICAL PERFORMANCE RESULTS HAVE CERTAIN INHERENT LIMITATIONS. UNLIKE THE RESULTS SHOWN IN AN ACTUAL PERFORMANCE RECORD, THESE RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, BECAUSE THESE TRADES HAVE NOT ACTUALLY BEEN EXECUTED, THESE RESULTS MAY HAVE UNDER-OR OVER-COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED OR HYPOTHETICAL TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THESE BEING SHOWN. 9

11 Historical V-Shaped Markets S&P 500 Index Performance and Volatility History % Minimum Drawdown, Type 2 means the recovery sets an all-time high Source: Bloomberg, Past performance is not indicative of future results. Index performance information is for illustrative purposes only, does not represent the performance of any actual investment or portfolio, and should not be viewed as a recommendation to buy/sell. It is not possible to invest directly in an index. Any hypothetical, backtested data illustrated herein is for illustrative purposes only, and is not representative of any investment or product. RESULTS BASED ON SIMULATED OR HYPOTHETICAL PERFORMANCE RESULTS HAVE CERTAIN INHERENT LIMITATIONS. UNLIKE THE RESULTS SHOWN IN AN ACTUAL PERFORMANCE RECORD, THESE RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, BECAUSE THESE TRADES HAVE NOT ACTUALLY BEEN EXECUTED, THESE RESULTS MAY HAVE UNDER-OR OVER-COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED OR HYPOTHETICAL TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THESE BEING SHOWN. 10

12 BREXIT Commentary The $2.08 trillion wiped off global equity markets on Friday after Britain voted to leave the European Union was the biggest daily loss ever, trumping the Lehman Brothers bankruptcy during the 2008 financial crisis and the Black Monday stock market crash of 1987 Financial Times, July 4, 2016 This central bank put may provide market stability for the time being. It also drives policymaking to illogical courses of action, such as negative interest rates, and stores up longterm problems, pushing investors into risky assets in search of yield and making equity and bond valuations unsustainably rich. Financial Times, July 20,

13 Managed Risk Benchmarks

14 S&P Managed Risk Indices 30 indices Designed as benchmarks for the managed risk investment industry. Equity exposure Targeted volatility Downside protection strategy Spans 5 equity segments, and 6 risk levels 13

15 S&P Managed Risk Indices Formation Set Volatility Limit Benchmark volatility with risk control indices, such as S&P Risk Control Indices Risk Control Indices are less volatile Create Synthetic Put Synthetic puts on risk control indices are cheaper than those on broad market Volatility of underlying assets is positively correlated to put prices To further reduce the downside risk, utilize constant-maturity put replication which is implemented using a delta adjustment to the equity exposure Avoid Turmoil and Generate Smoother Returns 14

16 Desired Behavior of the Cash Cushion Source: Milliman Financial Risk Management LLC, Performance is shown for illustrative purposes, and is not intended to be representative of any investment. performance is not a guarantee of future results. Past Proprietary & Confidential 15

17 Performance Statistics

18 S&P Managed Risk Indices Performance Source: S&P Dow Jones Indices LLC. Data as of March 31, Index performance based on total return in USD. Past performance is no guarantee of future results. Chart is provided for illustrative purposes and reflects hypothetical historical performance. Please see the Performance Disclosures at the end of this document for more information regarding the inherent limitations associated with back-tested performance. The launch date of the S&P Managed Risk Index Series was April 11, The launch date of the S&P 500 was March 4, The launch date of the S&P 400 was June 19, The launch date of the S&P 600 was October 28, The launch date of the S&P 400 was June 19, 1991.All information presented prior to the index launch date is back-tested. Back-tested performance is not actual performance, but is hypothetical. The back-test calculations are based on the same methodology that was in effect when the index was officially launched. Past performance is not a guarantee of future results. Please see the Performance Disclosure at for more information regarding the inherent limitations associated with back-tested performance. Source:. Bloomberg, Past performance is not indicative of future results. Index performance information is for illustrative purposes only, does not represent the performance of any actual investment or portfolio, and should not be viewed as a recommendation to buy/sell. It is not possible to invest directly in an index. Any hypothetical, backtested data illustrated herein is for illustrative purposes only, and is not representative of any investment or product. 17

19 S&P Managed Risk Index Historical Returns Source: S&P Dow Jones Indices LLC. Data as of March 31, Index performance based on total return in USD. Past performance is no guarantee of future results. Chart is provided for illustrative purposes and reflects hypothetical historical performance. Please see the Performance Disclosures at the end of this document for more information regarding the inherent limitations associated with back-tested performance. The launch date of the S&P Managed Risk Index Series was April 11, The launch date of the S&P 500 was March 4, The launch date of the S&P 400 was June 19, The launch date of the S&P 600 was October 28, The launch date of the S&P 400 was June 19, 1991.All information presented prior to the index launch date is back-tested. Back-tested performance is not actual performance, but is hypothetical. The back-test calculations are based on the same methodology that was in effect when the index was officially launched. Past performance is not a guarantee of future results. Please see the Performance Disclosure at for more information regarding the inherent limitations associated with back-tested performance. 18

20 S&P 500 Managed Risk Index Efficient Frontier Source: S&P Dow Jones Indices LLC. Data as of March 31, Index performance based on total return in USD. Past performance is no guarantee of future results. Chart is provided for illustrative purposes and reflects hypothetical historical performance. Please see the Performance Disclosures at the end of this document for more information regarding the inherent limitations associated with back-tested performance. The launch date of the S&P Managed Risk Index Series was April 11, The launch date of the S&P 500 was March 4, The launch date of the S&P 400 was June 19, The launch date of the S&P 600 was October 28, The launch date of the S&P 400 was June 19, 1991.All information presented prior to the index launch date is back-tested. Back-tested performance is not actual performance, but is hypothetical. The back-test calculations are based on the same methodology that was in effect when the index was officially launched. Past performance is not a guarantee of future results. Please see the Performance Disclosure at for more information regarding the inherent limitations associated with back-tested performance. 19

21 S&P 500 Managed Risk Index Sharpe / Max Drawdown Source: S&P Dow Jones Indices LLC. Data as of March 31, Index performance based on total return in USD. Past performance is no guarantee of future results. Chart is provided for illustrative purposes and reflects hypothetical historical performance. Please see the Performance Disclosures at the end of this document for more information regarding the inherent limitations associated with back-tested performance. The launch date of the S&P Managed Risk Index Series was April 11, The launch date of the S&P 500 was March 4, The launch date of the S&P 400 was June 19, The launch date of the S&P 600 was October 28, The launch date of the S&P 400 was June 19, 1991.All information presented prior to the index launch date is back-tested. Back-tested performance is not actual performance, but is hypothetical. The back-test calculations are based on the same methodology that was in effect when the index was officially launched. Past performance is not a guarantee of future results. Please see the Performance Disclosure at for more information regarding the inherent limitations associated with back-tested performance. 20

22 General Performance of Risk Managed Funds FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE DISTRIBUTED TO MEMBERS OF THE PUBLIC. 21

23 Managed Risk Peer Group 240 retirement funds with some type of dynamic risk management strategy Over $300 billion in AUM 22

24 Performance of Risk Managed Funds 23

25 Potential Strategy Adjustments

26 Potential Strategy Adjustments Cash Account Invest the Cash Account into US Treasuries instead of cash Volatility Management Target a volatility range or smooth measured volatility to reduce trading activity Reduce the time horizon for realized volatility calibration Remove Volatility Management Downside Protection Scale down the sensitivity of the hedge by changing Option maturity Protection level There is no guarantee that any investment or strategy will achieve its objectives, generate positive returns, or avoid losses. Proprietary & Confidential 25

27 Replace Cash with Treasury Notes Use 5-year Treasury Notes instead of cash as a cushion Collect additional term yield premium Participate in flight to quality gains during periods of equity market stress Reduce equity hedge size because equity and rates are negatively correlated Revert to using cash if: Necessary to hit volatility target Yield curve is inverted Proprietary & Confidential

28 Treasury Notes - Performance Aggregate Performance Comparison Using S&P Managed Risk Index S&P 500 Levels MR Index Levels (using Cash Reserve Asset) MR Index Levels (using 5-Year CMT Reserve Asset) THESE RESULTS ARE BASED ON SIMULATED OR HYPOTHETICAL PERFORMANCE RESULTS THAT HAVE CERTAIN INHERENT LIMITATIONS. UNLIKE THE RESULTS SHOWN IN AN ACTUAL PERFORMANCE RECORD, THESE RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, BECAUSE THESE TRADES HAVE NOT ACTUALLY BEEN EXECUTED, THESE RESULTS MAY HAVE UNDER-OR OVER-COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED OR HYPOTHETICAL TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THESE BEING SHOWN. Proprietary & Confidential

29 Downside Protection Only Remove volatility management Stop targeting a specific volatility Allow capital protection to scale up when volatility increases Results are more intuitive when compared to the underlying asset Creates a tail-like hedge Upside/downside capture is more predictable during sideways markets Can more easily incorporate exchange traded options if seeking gap protection Proprietary & Confidential

30 Downside Protection Only - Performance Aggregate Performance Comparison Using S&P Managed Risk Index 300 S&P 500 Levels MR LT-VMS MR Index Levels (Treasury Reserve) THESE RESULTS ARE BASED ON SIMULATED OR HYPOTHETICAL PERFORMANCE RESULTS THAT HAVE CERTAIN INHERENT LIMITATIONS. UNLIKE THE RESULTS SHOWN IN AN ACTUAL PERFORMANCE RECORD, THESE RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, BECAUSE THESE TRADES HAVE NOT ACTUALLY BEEN EXECUTED, THESE RESULTS MAY HAVE UNDER-OR OVER-COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED OR HYPOTHETICAL TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THESE BEING SHOWN. Proprietary & Confidential

31 Downside Protection Only - Performance Aggregate Performance Comparison Using S&P Managed Risk Index 40.00% 30.00% 20.00% 10.00% 0.00% % H1 CAGR S&P 500 Return MR Cash Cushion Return MR Treasury Cushion Return MR LT-VM + Treasury Return % % % % THESE RESULTS ARE BASED ON SIMULATED OR HYPOTHETICAL PERFORMANCE RESULTS THAT HAVE CERTAIN INHERENT LIMITATIONS. UNLIKE THE RESULTS SHOWN IN AN ACTUAL PERFORMANCE RECORD, THESE RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, BECAUSE THESE TRADES HAVE NOT ACTUALLY BEEN EXECUTED, THESE RESULTS MAY HAVE UNDER-OR OVER-COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED OR HYPOTHETICAL TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THESE BEING SHOWN. Proprietary & Confidential

32 Thank you Milliman Financial Risk Management LLC 71 S. Wacker Drive 31 st Floor Ph: