While the global economic growth outlook is still largely positive for equity markets over the short term, asset owners in Australia have been starting to take risk off the table and apply some protection to their portfolios.
Superannuation funds, for example, are adopting a variety of approaches to deal with the possibility of increased market volatility. Some are focused on diversification or using derivatives, given the cheap option pricing amid calm markets. Others, such as Future Fund, the country's Melbourne-based sovereign wealth fund, are relying on a high cash allocation.
Chris Trevillyan, director of investment strategy at Melbourne-based consultancy Frontier Advisors, said institutional investors were perplexed that market volatility was so low, given the high global uncertainty, politically at least. “The possibility that volatility could suddenly increase significantly is something that is concerning for asset owners,” he told AsianInvestor.
Frontier is generally advising clients to diversify growth asset exposure while adding protection to portfolios. Trevillyan said one of the best ways for Australian investors to diversify was to get more foreign-currency exposure, because historically the Aussie dollar weakens in a downturn. Over the medium term, Australian funds are investing more offshore, he said, though hard data is not easy to come by to illustrate this trend.
While the International Monetary Fund forecasts that global output will grow 3.5% this year and 3.6% in 2018, Trevillyan said clients were positioning themselves for a serious correction in global equities, something they saw as unlikely but possible.
When volatility is low, options and other derivatives at relatively low cost, and if volatility does spike, those options will provide some downside protection for a portfolio, he noted. “So with a opportunity of having some put options applied to the portfolio, there are certainly some clients who have taken that step.”
The chief investment officer of an Australian pension fund with A$6 billion ($4.76 billion) under management told AsianInvestor his institution took a view 18 months ago that returns available on traditional fixed income were stretched, with interest rates at generational lows. So it reduced its exposure to traditional fixed income and allocated the money to floating-rate debt.
As a follow on, the fund is now assessing what it can do to ensure its fixed income exposure is a little more defensive. The approach it chose involved employing an absolute-return bond strategy, while adding allocations into private equity and infrastructure.
“We are not trying to make huge calls. These are all risk-weighted calls,” said the CIO, who asked to remain anonymous. “We are looking at real-return, absolute-return-focused bonds and investments that are going to give us some return generation, but with a level of negative correlation to traditional markets in case they collapse.”
Institutions elsewhere in Asia have increasingly been making use of absolute-return fixed income strategies – which are typically unconstrained and benchmark-agnostic. For instance, in Taiwan, insurer Cathay Life and state fund the Bureau of Labor Funds have both pursued this approach.
Another approach has been to raise cash levels. The A$120 billion Future Fund is the most high-profile asset owner to have taken a highly defensive asset allocation stance in the past two years. After doubling its cash allocation to 20% in 2015, it raised it further to 23% in 2016, amid continued concerns about global stock markets. According to its latest statement, as of the end of March the allocation to cash was still above 20%.