Will managed volatility keep VA owners on track

Eric Henderson, senior vice president for annuities and life insurance with Nationwide in Columbus, Ohio points out that higher volatility is often, but not always, correlated with down markets. His firm uses that general historical result in its efforts to maintain a certain level of volatility in its managed volatility VAs. "What typically happens is as the volatility of the equity markets goes up, you try to change the nature of the funds so that the volatility of the entire fund stays within some range," he says. "And that can be done by changing your allocation between equities and bonds. It can be done by doing some futures or other types of hedging type of activity within the fund but the goal of the fund is to keep volatility in sort of a range or managed in some manner."

Will it work?

Managing volatility sounds like a good approach, but most of the portfolios trying it haven't experienced prolonged market declines so it's difficult to evaluate the strategies' long-term effectiveness. Writing in Investment News in late November, Thomas Hoop with Legg Mason reported that the managed volatility strategies performed well during the high volatility market from Oct. 8 to 16. Among the funds he studied: "While the S&P 500 declined 3.68 percent, 88 percent of the publicly available U.S. managed volatility funds beat the benchmark; the median excess return was 1.40 percent." The funds did well during the market's overall positive result for the full month, as well, he notes.

Hoop's research focused on funds but the results should apply to VA sub-accounts that use the same strategies. It's an encouraging result that also serves as a reminder for VA-owners that managing volatility is not the same as eliminating it. It's relative protection, not absolute. When the equity markets drop, most managed volatility strategies will still experience losses but they should be smaller than the applicable market benchmarks. There's likely to be a upside trade-off with some degree of benchmark underperformance, as well.

Managed volatility VAs can benefit both investors and insurers, says Henderson. He notes that the contracts' living benefits were "a lot richer" before the financial crisis and the significant decline in interest rates. Managed volatility products can allow insurers to provide richer benefits again. "One way to offer a richer living benefit is through the use of managed vol(atility) funds," he says. "It's a way to say I've got my normal living benefit design and the hedging that goes along with that. If I can offer some managed volatility, that allows me to offer some greater benefit to the client."