Super funds embrace derivatives to meet retirement goals

Superannuation funds are increasingly using derivatives to combat sequencing risk as the demand for more retirement-focused products grows, the latest Milliman survey shows.

Milliman head of fund advisory services Michael Armitage said as financial planning shifts to more goals-based advice, more protection strategies are being employed to improve long-term outcomes and minimise shortfall risks.

"Most super funds are using derivatives not only for risk management, but for dynamic asset allocation, physical security replacement and to enhance yield," he said.

And amid the Comprehensive Income Products for Retirement (CIPR) or MyRetirement discussions, it should include derivative strategies to address the dynamics of the pension phase for members. Armitage also warned insurers and defined benefit funds are facing similar asset-liability challenges.

Funds using downside protection strategies in the pension phase are expressing growing concern with fixed income's ability to provide diversification benefits given a potentially rising rate environment, Armitage added.

"Others are focused upon managing investor behaviour and smoothing portfolio performance to help members achieve their retirement goals," he said.

Four-in-five super funds (79%) are frequently using derivatives for risk management and hedging strategies, particularly for rebalancing portfolios and assisting with fund manager transitions.

The most popular methods include overlay structures (65%), external manager mandates (47%) and asset allocation core components (26%).

More than two-thirds (69%) of MySuper funds and choice or pension products (63%) however, don't employ any downside protection strategies; about 32% said objectives could be met without derivatives.

Derivatives are known to be complex and carry a negative perception, and it has dissuaded some super funds to embrace them, the survey said.

For funds that use derivatives understand they can improve efficiency and lower costs, which is extremely attractive in a low return environment, Armitage said.

Nearly all (91%) Australian funds used international swaps and derivatives association (ISDA) master agreements to trade OTC instruments.

Read more: MillimanCIPRComprehensive Income Products for RetirementMichael ArmitageMyRetirementMySuper
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