Volatility-managed ETFs could reduce losses and improve long-term risk adjusted returns.
Absa Corporate and Investment Bank (CIB) has launched South Africa’s first range of volatility managed Exchange Traded Funds (ETFs) via its NewFunds ETF platform. Listed on the JSE on 25 February 2019, the ETFs will give investors access to a focussed universe of liquid, JSE-listed shares whilst explicitly managing risk.
Investors will have three funds to choose from that match different risk appetites: High Growth, Moderate and Defensive.
“Effective risk management is shown to reduce losses and improve long-term risk adjusted returns,” says Len Jordaan, Head of ETF Distribution at Absa.
According to Jordaan, investors in equity markets generally understand that there is a risk that they could lose their money, but incorrectly equate high risk with high returns and are often left disappointed. In fact, he explains, the inverse is true.
Effective risk management and lowering risk is fundamental to improving long-term return potential.
Jordaan says markets are inconsistent, and any fall in value that an investor experiences means the fund will have to increase in value even more for it to revert to its initial position.
“It is for this reason that investors should have a well-implemented risk-management strategy, which will provide superior performance over the long-term,” he says.
“Through the Absa NewFunds Volatility Managed Equity range of exchange traded funds, we actively manage each fund’s allocation to equity shares (the ‘risky’ asset) and cash (the ‘risk-free’ asset) on a daily basis.”
These are the first funds in SA (including Unit Trust Funds) to explicitly target a fixed volatility, an idea borne from the hugely significant relationship between volatility (or risk) today and drawdowns/losses tomorrow.
“By targeting the amount of risk that each fund is exposed to, we aim to de-risk the portfolio when equity volatility is high but position the portfolio aggressively when equity volatility is low, all done via a robust index strategy,” he adds.
Each fund has a fixed Volatility Target that it maintains by adjusting the allocation to equities and cash every day, based on the prevailing realised volatility in the equity market.
This mechanism provides a very stable volatility experience for the investor. It also provides risk mitigation when markets are volatile (by increasing the allocation to cash) but allows investors to participate in rising equity markets by allocating more capital to equities when markets stabilise.
Absa’s strategy also overlays a maximum drawdown feature, so that the equity portfolio cannot lose more than a specified percentage relative to its high over the previous 125 days.
This feature is applied only in downward trending markets, so that the portfolio does not become ‘cash-locked’ after a period of high volatility but rather can quickly purchase equities when markets rise.
Ryan Sydow, Head of Distribution for Absa Index and Structured Solutions, says, “Investors, for the first time through a listed instrument, can invest and forget, safe in the knowledge that the volatility in the fund will always target their chosen level and that they will be in safe assets when it matters most.”
This article was originally published here
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