Institutional investors increasingly are embracing myriad volatility management strategies in an effort to control downside portfolio risk and still meet long-term return goals.
Sophisticated investors that implemented portfoliowide volatility management over the past few years — such as the C$47.4 billion (US$46.8 billion) Healthcare of Ontario Pension Plan, Toronto, and the $3.4 billion Fairfax County (Va.) Employees' Retirement System — have racked up strong track records of impressive returns that outperformed their benchmarks and their peers while keeping risk at bay.
The volatility-management options include individual low-volatility equity and bond strategies as well as global absolute-return funds; risk-parity and liability-driven portfolio construction; derivative overlays; and portfolio-level volatility control.
Like other large Canadian public pension plans, nearly all of HOOPP's portfolio is internally managed, using a liability-hedging portfolio consisting primarily of long government bonds, real return bonds and real estate with an overlay strategy of options, swaps and futures for equity exposure. There is also a 30% allocation to return-seeking investments.
The only stock picking in the portfolio comes from long/short equity strategies within the absolute-return portfolio. The rest of the equity exposure is obtained through derivatives in global stock markets, said James Keohane, president and CEO. The pension fund's derivatives contracts include foreign exchange forwards, equity and bond futures, and a variety of swaps and options with a total notional value of about $173 billion.
“We can actively construct the portfolio for better liability matching through derivatives,” Mr. Keohane said.
HOOPP returned 17.1% in 2012, outperforming its customized internal benchmark by 281 basis points. For the 10 years ended Dec. 31, the pension fund returned an annualized 10.3%, vs. 8.9% for its benchmark.
The pension plan's funded status is 104%.
“There will be scenarios where we underperform ... but our real objective is to have assets outperform liabilities,” Mr. Keohane said.