London Market Monitor – 31 August 2022
Our August review of the markets and Solvency II discount rates.
Often the best financial strategy is not the one that delivers the highest investment return.
While all investors value strong investment performance, for many, such as retirees, their main concern is making their money last rather than watching it grow.
Similarly, women typically prioritise financial security over the possibility of heady gains.
We know this, yet it is easy to lose sight of the importance of stability and prudent risk management when markets are indiscriminately climbing higher and products are marketed largely on outperformance.
In funds management, there is a tendency to glorify stock pickers over risk management professionals like actuaries.
Using ’80s cult movie Top Gun as an analogy, investors tend to admire and pursue traits like boldness and confidence, personified by Tom Cruise’s character Maverick, over qualities like discipline and stability, reflected in Val Kilmer’s Iceman.
Fortunately, they do not need to choose between the two. They can balance their dual requirement for sufficient returns to meet their long-term financial goals while ensuring they are not waylaid by a large market correction.
In short, they can have Maverick and Iceman, too.
One positive from Covid-19 is that it has reminded investors to construct portfolios responsibly for all market conditions.
It is changing the nature of advice conversations, requiring advisers to have more robust, in-depth discussions about portfolio construction and risk management.
Investors face a myriad of risks: longevity, sequencing, liquidity, et al. However, it is typically investment risk that is foremost in their minds, especially during a crisis.
This is particularly true of early-stage retirees and pre-retirees because their wealth is at its peak therefore they have the most to lose from a correction.
Covid-19 has reignited the debate about the effectiveness of traditional portfolio construction and financial planning strategies, like the bucket strategy, to provide a high level of insulation against market risk.
Bucket strategies essentially divide a client’s retirement savings pool into several accounts, typically three or four. Each account serves a different purpose and is earmarked for a particular timeframe (now, soon, and later).
It is a popular strategy because it is easy to understand and visualise, and extremely helpful at managing client behaviour.
That is because human beings tend to compartmentalise their lives and the bucket concept aligns to their thinking. During periods of financial stress, it is also easy to recall. If people know they have enough cash in Bucket one to meet their needs for the next few years without needing to sell assets in Bucket two or three, they’re less likely to panic and more likely to stay on course.
However, the biggest criticism of bucket strategies is that they do not provide protection against a severe, prolonged downturn.
They are only good as long as a market correction is moderate, followed swiftly by a strong rebound.
Unfortunately, it is impossible to predict how severe a correction will be and how long the recovery will take.
It took the Australian Market seven years to recover lost ground from the 1987 stock market crash1 and another 11 and a half years to recover from the 2008 Global Financial Crisis2. By contrast, Japan is still waiting for the Nikkei 225 to hit its previous peak in 1990.
There is a way for investors and advisers to address the risk management limitations of bucket strategies while maintaining upside exposure to investment markets.
The missing piece, until now, has been a flexible, low-cost risk management overlay, designed for retail investors.
Risk management overlay strategies are effectively an active asset allocation strategy, based on extensive stochastic modelling, designed to deliver stable returns over a full market cycle.
More commonly utilised by institutional investors like insurance companies and pension funds, Milliman’s traditional client-base, retail demand is growing due to increasingly volatile market conditions and changing demographics.
As more Australians approach and enter retirement, they want solutions that can insulate them from financial stress and deliver a smoother ride.
To help advisers build more resilient portfolios and to facilitate meaningful conversations, Milliman has launched a range of tools and solutions that quantify the benefits of risk management and aid the intelligent allocation of risk and fee budgets, see breakout.
The purpose of this article is not only to demonstrate the effectiveness of Milliman’s SmartShield Managed Accounts and our new Simulator, but also to encourage robust advice discussions and support advisers to insulate their clients from market risk and keep them on track to achieve their goals.
There is no better time than a crisis to proactively contact clients, review their situation and take steps to secure their future.
To foster robust client discussions during this challenging time and, beyond Covid-19, keep risk management at the fore, Milliman has launched a range of tools and solutions to help advisers quantify the benefits of risk management and intelligently allocate risk and fee budgets.
With the Milliman SmartShield Managed Accounts, retail investors can now access the investment insights, risk management expertise, and best ideas of Milliman’s large, global team.
They can gain upside exposure to investment markets while limiting or shielding the impact of a market correction.
While many other products claim to provide downside protection, they typically come with limitations such as illiquidity, lack of flexibility, and high fees. They are not ideally suited to retail investors.
SmartShield addresses these limitations and is designed to support the advice process. Advisers can dynamically turn protection on and off as needed, based on their client’s individual circumstances and needs.
The primary outcomes are smoother returns and a more comfortable client experience.
The new Milliman Risk Simulator is an online portfolio construction tool that allows advisers to input client data like target retirement age, current investment balance and target income, to see the impact that these new SmartShield Managed Accounts can have, by portraying various scenarios on a client’s goals.
Users can see how a portfolio will perform under normal conditions, with and without risk protection. They can also see how a portfolio will perform in a severe market downturn, for example the GFC or a Covid-19 scenario.
It enables investors and advisers to view the clear benefits and then weigh up the application of a risk management strategy, over and above a portfolio that does not include this.
For more information, visit https://advice.milliman.com
1The Sydney Morning Herald. 1987? That's not a crash, this is a crash. Retrieved from https://www.smh.com.au/business/1987-thats-not-a-crash-this-is-a-crash-20121019-27wre.html.
2Financial Review. The ASX's long, long road to recovery. Retrieved from https://www.afr.com/markets/equity-markets/the-asx-s-long-long-road-to-recovery-20190725-p52aop.