投資家にはそれぞれ、現在の環境で自身のポートフォリオを損失から守る理由があります。
感染症流行の結果、インフレが急上昇し、ロシアによるウクライナへの侵攻がグローバルな安定性を脅かす中、記録的低金利から金利を吊り上げました。
しかしポートフォリオ保護戦略があることで、プロテクションの費用が長期的恩恵を上回る場合には、逆効果となることもあります。
In this short article, Victor Huang explores the ongoing costs of some typical downside risk management strategies.
Investors have good reason to consider protecting their portfolios in the current environment.
Inflation is quickly rising in the wake of the pandemic, driving up interest rates from historic lows, while Russia’s invasion of Ukraine threatens global stability.
But having portfolio protection can backfire if the cost of protection outweighs the long-term benefits.
Measuring the true cost of popular portfolio protection strategies
Investors need to choose the right strategy to strike the appropriate balance, even as the market’s long held risk-return paradigm is changing.
Inflation has been on a downward trend for decades, helping lift asset valuations, but that situation may be coming to an end.
U.S. inflation hit its highest level in four decades in January, prompting the U.S. Federal Reserve to raise rates by a quarter percentage point in March – the first upward hike in four years.
Other central banks, such as The Bank of England, have already raised rates, and pressure is now mounting on the Reserve Bank of Australia. Australia's unemployment rate has fallen to just 4% – its lowest level since 2008 – yet interest rates remain pegged at an historic low of 0.1%.
The threat of higher inflation and rates has already wreaked havoc on some growth-oriented market sectors, such as technology, although overall market returns remain relatively solid for now.
Many investors, particularly those exposed to sequencing risk, will want their portfolios protected from these new risks.
Put options: Effective but expensive
Put options are a commonly used explicit strategy to protect portfolios from a market crash. Put options give an investor the right to sell an asset that falls to a predetermined price within a certain timeframe. This limits losses in a falling market.
Put options can be purchased on major market indices and provide full protection. However, they are expensive and aren’t considered to be agile.
Figure 1 shows that the annual cost of full protection for the ASX 200 has varied from 4% to 21% over the past 15 years. Unfortunately, for investors the cost of put options soars when they need protection the most – during volatile or falling markets.
Figure 1: Cost to Protect ASX200 Using One-Year Put Options (as a % of notional protected)
The cost of a one-year at-the-money put option on the ASX 200 is currently at about 8%,1 which creates a significant drag on performance.
Even if put options are used to protect falls greater than 10%, the cost has still varied between 1% to 13% over the same period. This strategy would currently cost investors about 5%.
Given the potential drag on long-term portfolio performance, in isolation, put options are difficult to implement as an ‘always-on’ protection strategy.
The hidden cost of lowering exposure to growth assets
Another popular strategy to manage downside risk is to lower a portfolio’s allocation to volatile assets such as shares.
But this also has a hidden cost – lower expected long-term returns.
A Milliman analysis shows that shifting from a Growth to a Balanced fund results in a 1.1% reduction in expected annual returns.2 For a retiree at age 67 (who withdraws $25,000 a year indexed to inflation), the compound effect of those lower returns is expected to more than halve the amount of money they have or are able to leave behind at 90,3 from $245,000 to $120,000 on average.
Meanwhile, the effectiveness of de-risking by shifting exposures to fixed interest is under question in the current market, where inflationary pressures are forcing a tightening of monetary policy.
Higher inflation could push the yield curve up, leading to negative bond returns.
An institutional approach to manage downside risk
Institutional investors, such as large insurance firms and superannuation funds, tend to rely on more dynamic strategies to protect their portfolios.
One such approach is using futures contracts, which can be traded dynamically across highly liquid global exchanges, to replicate put option payoffs.
Milliman’s SmartShield managed accounts, which were launched just as the COVID-19 crisis hit in early 2020, allow retail investors to implement this approach, cushioning their portfolios against market volatility and extended downturns.
These managed accounts provide risk management more efficiently by:
- Using futures contracts to manufacture put option payoffs rather than purchasing them directly. Over the long-term this is expected to be more cost-effective as a result of avoiding the implied volatility premium and skew typically associated with options.
- Tilting each of the SmartShield portfolios more towards growth assets relative to their benchmarks to help fund the risk management strategy over the long-term.
- Leveraging the scale built across Milliman’s 24-hour-a-day global trading desk which services institutional clients to bring down fixed costs. Milliman provides investment advisory, hedging and consulting services across this platform on $176.1 billion in global assets (at December 31, 2021).
The result of this approach can be seen in the performance of SmartShield’s High Growth managed account portfolio in Figure 2. Throughout the initial COVID-19 sell-off, the portfolio fell just 7% compared to its benchmark, which lost 21%.
To date, it has returned a similar result to its benchmark, but with far less volatility and a much smaller maximum drawdown. Importantly, the portfolio was protected if the downturn dragged on (which occurred during the Global Financial Crisis of 2008-09).
Figure 2: SmartShield High Growth Cumulative Net Performance Since Inception
This is crucial for retirees and pre retirees, who don’t have the time in the market to benefit from an eventual rebound. Their losses are compounded because they are drawing down assets at a low point, rather than accumulating assets when they are cheap.
But many other younger investors, who have not experienced a prolonged market downturn, are also risk averse.
A smoother ride can help give them the confidence to stay invested rather than withdraw and lock in losses, while making difficult client conversations easier during times of crisis.
You can check the potential benefits of downside protection on your client portfolios at https://advice.milliman.com/en/insight/The-SmartShield-digital-portfolio-simulator.
For more information about Milliman go to https://au.milliman.com/en/
2Based on Milliman’s standard calibration of the Milliman GBA Platform as of 31st December 2021. Results based on simulated or hypothetical performance have certain inherent limitations.
3Results based on 5,000 simulated scenarios using Milliman’s standard calibration of the Milliman GBA Platform as of 31st December 2021. Simulated or hypothetical performance has certain inherent limitations. See https://smartshield.millimandigital.com for more information.