Volatility gives Australian superannuation fund members a “rough ride” as it results in lower returns than the same strategy would with less volatility, according to Parametric.
The US-based fund manager’s report explained why superannuation funds needed to focus on both ‘managing the journey’ and the ‘destination’, by smoothing the fund member’s journey to accumulate the retirement savings and help them prevent the erosion of their portfolios.
According to Raewyn Williams and Tom Lee, the authors of the report “A Wide Angle Lens View of volatility: Managing the Journey and Destinations”, the larger portfolios, higher returns, higher volatility or longer time periods could all increase the leakage, which they described as similar to other ‘hidden leakages’ such as fees, taxes or transaction costs that eat away at member returns over time.
“Current solutions do not typically address these leakages because they are usually not measured, disclosed or well understood,” they said.
“Our research argues that in addressing volatility, funds can, and should, do better than simply address the journey problem — they need to find solutions to address the destination problem as well.”
Therefore, Parametric offered a defensive equity solution, designed to reduce volatility in superannuation funds’ equity portfolio and provide a substitute source of income to help replenish account balances, which could be implemented over Australian or international equity portfolios.
They stressed that it would help de-risk a part of the portfolio from equities into defensive assets, which would also offer a solution to the “journey problem”, while the “destination problem” could be addressed by introducing a put and call writing overlay that positioned the fund on the sell-side of the option protection and speculation other funds were buying.
Additionally, according to the report, such an approach would also help avoid the costliness of buying protection by being on the sell-side, and other issues like liquidity and counterparty risk.
“Members will no doubt take a ‘wide angle lens’ view of their superannuation experience, caring equally about their journey and destination. Funds should be excited about solutions that do not ask them to choose between the two, but neatly address both.”
