- What a Synthetic Annuity Is-and Is Not
- Background
- The Effects of Volatility on Investor Returns
- Revisiting Modern Portfolio Theory
- Moving Forward
- How Do SynAs Fit into the Picture?
- Reducing Risk, Seeking Returns, or Both?
This chapter is from the book
This chapter is from the book
This chapter is from the book
Reducing Risk, Seeking Returns, or Both?
Because I have talked so much about risk, I might have given the impression that a SynA is a defensive tool. It is, but my objective has always been offense, finding ways to increase returns. I have always thought that the better the risk control, the more opportunities you have to be aggressive.
In “A Qualified Commitment to DB Plans,” (2009) CFO Research Services surveyed plan sponsors of defined benefit plans on a number of topics related to risk management during the 2008–2009 financial crisis. The sponsors were asked, “Going forward, are you more focused on increasing investment returns or decreasing investment risks?” More than three-quarters answered: reducing risk. An interesting aspect of the survey was that the companies that were more interested in increasing returns also had the most sophisticated approach to risk management:
- The deep economic recession has battered most defined benefit (DB) pension plans, and many sponsors have been scrambling to address risk. ... Consistent with past studies, more than three-quarters of survey respondents say they will focus more on reducing risk than on seeking additional returns. However, those companies that are focused on seeking additional returns are far more likely—by a three-to-one ratio—to already use synthetic hedges than those companies focused more on reducing risk. One conclusion is that those seeking additional returns have already addressed important components of pension risk. To put it another way, reducing risk and seeking returns are not mutually exclusive.12
That is exactly the objective of a SynA: to be aggressive in seeking returns, and do it within a disciplined risk-management framework. To do that, a SynA creates a hybrid architecture that balances the long-term investor perspective of mean-variance portfolios and the risk discipline of quantitative-based strategies.