Putting Volatility in the De-Risking Driver’s Seat

As of late last year, most asset owners (59%) felt that the asset management industry hadn’t stepped up with enough innovation in liability-driven investing strategies, according to a Natixis Global Asset Management survey.

At least one provider is looking to rectify that.

UBS has released a white paper detailing its new theory on wrapping volatility targets into a de-risking glide path, making dampened funded-status movements part of the driver for asset allocation, not just the intended outcome.

“The target funding ratio volatility model is the hands down winner across all seven time periods.”

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The banking and asset management giant ran four test cases for a model plan: a classic 60/40 equities and bond portfolio, an asset glide path (AGP) that de-risked as funded status improved, an AGP with a target funding volatility overlay, and an AGP with a dynamic glide path-style volatility overlay.

The overlays—which UBS called “fairly straightforward,” “highly liquid, and inexpensive to trade”—comprised of S&P 500 and US Treasury futures.

The final test case, involving both an asset allocation glide path and dynamic funding volatility overlay, produced the best risk-adjusted returns for the June 2001-through-February 2015 backtest period.

“The target volatility overlay helped reduce the allocation to equities in 2008, which explains why its maximum drawdown is not as extreme as compared with the two asset allocation approaches,” wrote UBS advisor Neil Olympio and Head of Pension Risk Management Robert Guzman.

The authors acknowledged that this approach would likely underperform relative to a classic AGP in certain periods, particularly during strong and volatile equity bull markets.

“This is because the dynamic target funding ratio volatility portfolio could reduce equity exposure enough so that the AGP model portfolio would produce a better return,” Guzman and Olympio noted. “Even then, the results would have to be compared on a risk-adjusted basis.”

UBS LDI 2

Interested in reading UBS Global Asset Management’s paper—“From Liability to Volatility Driven Investing”—in its entirety?

Successful fund launches since the turn of the century may have been “a function of luck, not skill”, according to a damning report into asset managers’ product development.

Half of all investment strategies launched since 2000 failed to raise $200 million, “even after 10 years of distribution”, according to the report from consultancy Casey Quirk. Only a quarter of launches hit $1 billion, and only one in 10 had reached this milestone within three years of launching.

“For many asset management firms, the product development processes that arguably aim to encourage innovation actually stifle it.” —Casey QuirkCasey Quirk—which provides specialist advice to asset management companies—predicted that the majority of existing “traditional” investment products would see trillions of dollars withdrawn by retail and institutional clients in the next five years. Equity funds were expected to see more the $2 trillion withdrawn by 2020.

But “weak product development processes” are restricting managers from moving away from benchmark-oriented funds towards multi-asset or quantitative products, the consultancy claimed.

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The report—“New Arrows for the Quiver: Product Development for a New Active and Beta World”—said most senior executives at large groups recognize the importance of product development “but also rate themselves highly at developing new products”.

Future asset flows - Casey Quirk “A broader industry perspective, however, reveals that creating ‘big winners’ might be a function of luck, not skill,” the report said. “The ‘blockbuster’ investment strategies that asset management executives crave are few and far between.”

Casey Quirk highlighted several shortcomings by asset managers when developing new strategies. These included overestimating demand, charging fees “out of line with market expectations”, or building strategies that are too complex for distributors to explain.

“Asset management firms that agree to question all beliefs, and design product arrays without pre-existing conditions, tend to fare better.”In addition, the report claimed that many promising ideas “never see the light of day” as they are “mired in governance processes that become overly bureaucratic or wedded to ‘sacred cows’—in this case, increasingly less relevant views on active asset management (many related to benchmark-oriented investing) that investment professionals are reluctant to discard.”

“For many asset management firms, the product development processes that arguably aim to encourage innovation actually stifle it,” the report said. “Weaker processes also often result in delayed product launches and products designed by consensus.”

To solve these issues, Casey Quirk urged asset management executives to set out clear strategies for their businesses. The report cited the importance of discipline, governance, creativity, collaboration, and rejecting “sacred cows”.

“Most well-intentioned asset managers agree to develop products within existing investment theses and beliefs without questioning their future relevance,” Casey Quirk’s report said. “This leads to product proliferation: development groups add products to innovate, but simultaneously maintain legacy products, often at the behest of portfolio managers.”

“Asset management firms that agree to question all beliefs, and design product arrays without pre-existing conditions, tend to fare better,” the consultancy said.