Liquidity strategies can help manage systemic volatility in some situations but given investment markets have exited a long period of low volatility and entered a new cycle of higher volatility, managers must pay close attention to how and why they choose to implement strategies.
During the Fiduciary Investors Symposium in Healesville, Victoria, in November, an expert panel of managers discussed the benefits and risks of strategies such as minimum volatility, risk parity, risk neutrality, short VIX and exchange-traded funds in systemic risk.
ipac Investment Management CIO Jeff Rogers noted that ipac runs a targeted volatility strategy for AMP for its variable annuity product.
“The idea is that you build a diversified portfolio of largely equity exposures and you respond to the volatility environment,” Rogers said. “It’s important to understand that the target volatility fund is responding to volatility – not levels of movement in price but movement in volatility.
“Depending on the nature of that spike in volatility, you’ll either go back to normal levels of exposure or to lower-than-normal levels of exposure, in high-volatility regimes…Then, AMP or the insurer can come in and offer guarantees because it’s much easier for them to guarantee a level or a rate of return on a fund that has a stable volatility, as opposed to a variable volatility.”
Avant Mutual CIO John Lucey espoused a different approach. He said Avant did not implement any of the strategies the panel discussed because of concerns over introducing complexity, when a diversified portfolio with active managers could be a better strategy.
“With these strategies, we’re getting very specialised and narrow exposures,” Lucey said. “As we’ve seen in Australia…the fund chasing these kinds of exposures can have unintended consequences. That’s a big concern for me around what we’re seeing in the market, around things like ETFs. I’ve used ETFs extensively in the past but when you get this mismatch between the liquidity of the ETF, which is listed and trading daily, and the liquidity of the underlying instruments, that mismatch around what we’re seeing with high yield and credit and the like – that’s a real worry.”
The panel also raised concerns about rebalancing risks if members switch out of certain superannuation fund options and into cash, because those kinds of moves can affect liquidity over the short term, even if super funds are long-term investors.
“Liquidity is there until you need it, and then it’s not there anymore,” Lucey noted. “The more specialised the exposures we get and the more complex the exposures, the harder it is to rebalance.”