United States-based foundation Margaret A Cargill Philanthropies (MACP) has expanded its weighting to risk premia strategies from 3 per cent to 5 per cent of the total portfolio and has added volatility risk premia strategies to its line-up.
But Michael Ruetz, Deputy Chief Investment Officer at MACP, says the two measures should be seen apart, since the new premium is not simply receiving the additional 2 per cent weighting.
“We have increased our allocation to 5 per cent and part of that increase was motivated by us adding volatility selling,” Ruetz says in an interview with [i3] Insights.
“Now, we didn’t allocate the 2 per cent, or the 40 per cent of the risk premia portfolio, to volatility selling per se. We wanted to ensure that if we increased [the weighting] that we more or less could keep the relative sizing of carry, momentum and value, and then add volatility.”
Ruetz and the team at MACP helped to develop the new volatility-selling strategies in partnership with its external managers and came up with implementations for each asset class.
“I would say that a key difference with volatility selling relative to the other individual risk premia strategies we’ve invested in is that we co-developed the volatility-selling strategies with select groups that are now executing the strategies for us,” he says.
“For example, one of our research partners has a lot of expertise in foreign currency and a lot of historical derivatives data. So we were able to benefit from their market knowledge and utilise a very rich set of data to help co-develop the strategy.
“Another example includes us working with senior traders and researchers from a large agribusiness to develop a commodity volatility-selling strategy. Their market knowledge and trade execution insights were quite valuable to the research process.”
We have always been very forthcoming with the fact that there is an economic risk within the individual premia in general,” he says. “We can’t expect absolute positive returns year in year out
The addition of the new risk premium shows the fund’s commitment to factor investing, but it hasn’t come without some soul-searching.
Ruetz acknowledges 2018 was not great for risk premia strategies and the fourth quarter proved to be especially challenging.
“There is sort of a belief, or theory, that risk premia should hold up. We tend to believe that over long periods of time risk premia will hold up well, but it is not negatively correlated, so it is not necessarily intended to be an offset [to equity markets],” he says.
Risk premia strategies have proven very popular in recent times and are sometimes seen as an all-weather type of solution.
And although over the long term certain risk premia strategies can provide a diversified positive return to equities, over shorter time frames they are not without risk, Ruetz says.
“We have always been very forthcoming with the fact that there is an economic risk within the individual premia in general. We can’t expect absolute positive returns year in, year out,” he says.
“There are strategies that are countercyclical in the risk premia portfolio, such as commodity carry and time series rates momentum. Commodity carry is really a form of supply risk and it is countercyclical from the standpoint that with an economic decline you typically see the front end of commodity curves sell off relative to the back end and that can benefit the portfolio.
“The same with rates momentum; you expect to get long interest rates as the equity market declines.”
We manage towards an 8 per cent volatility target and therefore we have to apply leverage given the low correlations among individual premia
The added volatility risk premium has its own idiosyncratic risk and in this case it means MACP is a little bit more conservative with leveraging the volatility-selling strategies.
Whereas in other risk premia strategies MACP applies a leverage ratio of about four to six times, in the volatility-selling strategies the leverage is capped at approximately one half the other strategies.
“We manage towards an 8 per cent volatility target and therefore we have to apply leverage given the low correlations among individual premia. Today, at the portfolio level, the average is six times leverage,” Ruetz says.
“We apply a leverage cap to the volatility-selling strategies for two reasons: volatility selling will typically experience sharp losses during market declines. So in an effort to minimise and reduce the conditional equity market beta in the risk premia portfolio, we try to keep the latent market risk relatively low.
“Another consideration for doing so is cash management. Some of the volatility-selling strategies require a fair bit of margin, and it is known that volatility selling will go down at times when other strategies, such as foreign currency carry, do too.
“So we just want to be prudent with our cash management, given the margin requirements.”
[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe.