Superannuation funds would have benefited from an options management strategy that reduces volatility and risk without compromising returns during the global financial crisis, according to Triple 3 Partners.
Triple 3 senior principal Simon Ho said that options were a fantastic tool with which to reshape a distribution curve compared to tail risk hedging. He added that tail risk hedging could protect funds in a serious downturn, but was expensive and essentially shifted the entire distribution curve downwards.
Both Triple 3’s volatility strategy and tail risking hedging attempt to reduce the risk that results a lack of diversification, whereby in serious downturns the correlation between asset classes increases.
But Triple 3’s method of creating a volatility overlay can be tailored to specific fund requirements, for example reducing standard deviation to a specific level or abiding to set rolling 12 month loss levels, so that stock losses will not exceed a certain level.
In contrast tail risk hedging has a negative expected value and only does well when markets sell off sharply, and also cannot be tailored to individual fund needs, Ho said.
Ho argues that for long running investors it’s far better to reduce variability of returns than cut off the left-hand side of profit distribution, which is what tail risk hedging does.
“Options are by far and away the best tool to manage risk but they are widely underappreciated and underutilised,” Ho said.
Triple 3 Partners creates a portfolio of options that is designed to reshape the portfolio a client wants, and can go both long and short, Ho said. The firm can conform to set volatility constraints for individual clients, and can achieve that without taking away from returns, he said.
The detriment comes when there is a sharp rally in the index, because by reducing volatility you also miss out on some of the upside, Ho said.
But by reducing volatility without compromising long-term performance the result is improved risk-adjusted returns, he said.
