In a year of geopolitical turmoil, MLC Asset Management has relied on dynamic asset allocation to hedge against some of the potentially devastating effects on investment portfolios. We speak to CIO Dan Farmer about examples of trades he implemented to mitigate these risks.
Superannuation funds are not known to take big asset allocation bets, where they move in excess of five per cent of the portfolio to any particular position that might express their view on markets.
But funds are increasingly using dynamic asset allocation (DAA) to mitigate some of the worst tail risks in their portfolio, protect the fund against today’s heightened volatility in markets and eke out a little extra return.
Our DAA process considers the risks. We really try to position for multiple scenarios. We think about different ways it can play out, and how our portfolio will perform, and then try and take the sharp edges off those potential outcomes through positioning
Dan Farmer, Chief Investment Officer of MLC Asset Management (MLC AM), says DAA is an important tool in risk management for his team.
“Our DAA process considers the risks. We really try to position for multiple scenarios. We think about different ways it can play out and how our portfolio will perform, and then try and take the sharp edges off those potential outcomes through positioning,” Farmer says.
Preparing for a range of different scenarios is quite different from making an asset allocation call based on a high-conviction view, he says.
“It’s very dangerous to try and predict an outcome. How is this going to end? Where are we going to be exactly in three months’ time? And then position your portfolio around that. Because, invariably, you’ll be wrong or even if you’re right, the markets may react in different ways,” he says.
The Liberation Day Derivative Trade
In a year of geopolitical turmoil, where the election of Donald Trump as President of the United States kicked off a global trade war, while tensions in the Middle East boiled over and saw Iran being drawn into the regional conflict, DAA offers a way to hedge against some of the worst effects on investment portfolios.
Last year, Farmer and his team put on a dispersion trade to protect the portfolio from a further ramp up in Magnificent Seven stock prices. This type of trade involves a strategy that buys options on stocks that are expected to outperform, while selling options on stocks that are expected to underperform or remain stable.
The team applied a similar technique this year to hedge the portfolio against the effects of deglobalisation in the ramp-up to the so-called ‘Liberation Day’, when, on 2 April, Trump implemented a range of import tariffs on countries around the world and kicked off a global trade war.
“Trump was clearly talking about tariffs and, basically, home-shoring a lot of manufacturing,” Farmer says.
“We put on a trade which was a deglobalisation dispersion trade, where we look at the correlation between a number of companies and industries that would benefit prima facie from home-shoring and a group of companies that would suffer from this.
We put on a trade which was a deglobalisation dispersion trade, where we look at the correlation between a number of companies and industries that would benefit prima faci from home-shoring and a group of companies that would suffer from this
“On the short side, think of European auto manufacturers, while [on the long side] we looked at things like US internal logistics. And that played out pretty well.”
In these types of trades, the fund doesn’t have to get the direction of the price movement right, but simply benefits from a change in correlations.
“It was a non-directional trade so it didn’t matter whether Trump was putting higher or lower tariffs [in place], it was just that the correlation between those two baskets would change. Those are the sort of geopolitical risks that we try to manage without taking big bets,” Farmer says.
Protecting Against Oil Price Spikes
A more recent example of risk management through DAA involved hedging the portfolio against a spike in oil prices following the Israeli and US rocket strikes on nuclear facilities in Iran.
MLC AM manages a range of real return funds that are sensitive to inflation. A spike in the oil price could drastically impact their performance.
“In our real return funds that are trying to match CPI on a shorter-term basis, clearly the trouble in the Middle East, the oil price impact and inflation puts pressure on these real returns,” Farmer says.
“So we used oil options to protect us from [oil prices blowing] up on the upside. The oil price really did and it’s obviously come back now, but it provided insurance against that outcome for those funds.”
Implementing an option strategy is a relatively low-cost way to buy protection against tail-risk events, he says. “We’re happy to pay a very small amount of money to protect against that potential outcome,” he says.
Contingent Downside Protection
Another, more novel, position MLC AM took to protect against the worst fallout of the tariff war was what is called a ‘contingent downside protection’ trade.
Under these types of trades, the derivative component of the trade is only activated when a certain threshold is reached in another asset or asset class that it is tied to.
“What we were doing there is basically an equity downside put that was contingent on the US 10-year [Treasury] bond selling off, because the scenario we’re worried about was if tariffs are going to be higher, then inflation goes higher, the US 10-year sells off and equity markets fall,” Farmer says.
“So that helped us to put that protection in place pretty cheaply and have the confidence to buy the actual physical equities back to benchmark.”
Holding an Equity Neutral Position
In aggregate, Farmer has held a neutral position to equities this year, despite international equity values soaring to great heights last financial year and the geopolitical turmoil associated with the election of Trump in early 2025, while tensions in the Middle East were rising.
Keeping a neutral weight to equities has worked out well for MLC AM as its MySuper Growth Fund, the largest of its default funds, produced a return of 10.1 per cent for the year, after an already stellar year last year, when it returned almost 17 per cent.
“We’ve held those equity weights because when you look through that, I won’t call it noise, but if you look through those distractions on a longer-term basis, the fundamentals of corporates around the world are still in good shape,” Farmer says.
Holding that neutral weight sounds easy, but there were times where that was pretty challenging, right? When you’ve had tariff news breaking, it would have been easy to get into an underweight position
“Balance sheets are strong. Earnings momentum is still reasonably healthy. Now, you can question the resilience of that, but earnings are still quite healthy.
“So corporations are in good shape and underneath that we still think the US economy is cyclically quite good. We’re expecting a slowdown in economic growth later this year, but we’re not expecting a recession.
“Put that together with the post-Trump Liberation Day equity sell-off and the equity market dynamics are actually quite positive.”
Aggressively Rebalancing the Equity Portfolio
Farmer says the firm resisted the urge to go underweight equities during the height of the tariff war turmoil and kept rebalancing back to neutral.
“Holding that neutral weight sounds easy, but there were times where that was pretty challenging, right? When you’ve had tariff news breaking, it would have been easy to get into an underweight position,” he says.
“During Liberation Day, we saw a sharp sell-off on the back of the tariffs being much higher than I think nearly anyone was anticipating. That’s a moment where you sit and think: Do we sell equities?
“We recalled the first term of Trump and said: ‘Let’s react to what he does rather than what he says.’ So we looked through that and we didn’t [quite] go overweight equities, but we were, I would say, aggressively rebalancing back to our neutral benchmark.
“Now that may not sound very exciting, but that actually helped us because it was actually quite tempting to go underweight. The sky is falling in. Is there going to be inflation?
“But our process is very disciplined, so let’s look through it.”
Takeover Bid Still on the Table
Insignia Financial, the parent company of MLC Asset Management, has recently been the subject of several takeover offers. Earlier this week, CC Capital informed Insignia Financial that it continues to ‘actively work towards making a binding bid for the company’.
CC Capital said it was finalising financing and investment committee approvals, a process that is expected to be completed in the next two weeks.
However, the company said there is no certainty that the ongoing discussions will result in any transaction being put to Insignia Financial shareholders for their consideration.
In March, CC Capital offered to buy all of Insignia’s outstanding shares for $5 a share, an offer that Insignia’s board said was ‘attractive’ to shareholders.
Last year, Bain Capital Private Equity launched a bid of $4 a share, an offer which Insignia rejected. In March, Bain indicated it was planning to match the CC Capital offer of $5 a share, but pulled out of the race two months later, citing ‘macro uncertainty caused by the volatility in global capital markets’.
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