Super funds and weapons of mass destruction

Warren Buffett may have called derivatives "financial weapons of mass destruction" but an increasing number of super funds are using them as a cost-saving measure.

Milliman head of fund advisory services Michael Armitage told delegates at the Australian Institute of Superannuation Trustees Super Investment Conference that the zero-to-negative interest rate environment is pushing super funds to increase their derivatives exposure, especially in late-stage accumulation products which are more heavily exposed to sequencing risk.

"While a lot of people associate derivatives with hedging strategies, they're also being used for more efficient cost saving. For instance, taking a futures long position rather than using an active long manager," he said.

"As you get towards retirement, the way you manage liability changes and this will lead to a framework where derivatives make more sense."

Referencing Milliman research on super funds' use of these financial instruments, Armitage said that 69% of respondents used derivatives as a derivative overlay, 31% considered them a core component of their asset allocation and 41.4% only used derivatives through an external manager.

When asked why they used derivatives, 57% cited their usefulness as a risk management strategy, while very few (43% never and 50% sometimes) used them as a source of incremental yield.

"By and large, the industry is still in an  accumulation mindset, but as that changes I think you'll see an uptake in derivatives usage," Armitage said.

"Cost is the primary reason, but also diversification, because the main advantage you get is asymmetric exposure."

Read more: MillimanWarren BuffettMichael ArmitageAustralian Institute of Superannuation Trustees Super Investment Conference
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