Super funds embrace derivatives

Australian superannuation funds are embracing derivatives to fulfil various investment functions, according to a Milliman survey.

Four in five funds (79 per cent) are either “always” or “often” using derivatives for risk management and hedging while 48 per cent “often” or “sometimes” use it for fund manager transition management.

Milliman head of fund advisory services, Michael Armitage said: “Milliman’s survey results show the Australian industry has a mature and healthy approach to derivative use”.

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

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Armitage added he was pleased to see funds were not using derivatives to take on excessive risk, with 85 per cent of funds saying they “never” used derivatives to leverage exposure.  

Surprisingly, 69 per cent of MySuper funds and 63 per cent of choice/pension products still did not use any explicit downside protection strategies despite the global financial crisis revealing the limitations of diversification as a risk management strategy.

The Comprehensive Income for Retirement Products (CIPR) discussions would bring into focus the need to tackle the dynamics of pension phase for members, Milliman said.

“Funds utilising downside protection in the pension phase are expressing growing concern with fixed income’s ability to provide diversification benefits given a potentially rising rate environment,” Armitage said.

“Others are focused upon managing investor behaviour and smoothing portfolio performance to help members achieve their retirement goals.”

For funds that chose not to use derivatives, 32 per cent believed they could meet their objectives without them, 18 per cent were concerned that the complexity overshadowed the benefits, and nine per cent cited negative perception surrounding derivatives.