Sophisticated investors don’t often think of variable annuities as vehicles for cutting-edge asset allocation strategies because of the limited fund choices and risk-mitigation techniques long associated with the products. That’s old thinking.
Indeed, many new VAs, a sampling of which was reviewed by National Underwriter, offer an extraordinarily diverse range of investments and risk-mitigation strategies inside the products’ subaccounts.
Among these, says Cindy Galiano, a portfolio manager of Morningstar Investment Management, Chicago, are absolute return and overlay derivative strategies that hedge against market volatility; and inflation-hedging or fixed income vehicles, such as unconstrained bond funds or floating rate bond funds, that hedge against rising interest rates.
VA makers, adds Galiano, are also employing tactical and dynamic asset allocation strategies that manage risk within the VA subaccounts rather than switch between equities and fixed income assets at the contract level. And they’re offering exchange-traded funds that (typically) track indexes like the S&P 500 and that appeal to investors because of their low fees, tax efficiency and stock-like features.
To hedge against market risks, carriers are also availing clients of “alternative investments” that have been much in demand since the downturn. Chief among these are commodity funds that invest in precious metals and futures. A $420 billion market, commodities increasingly appeal to investors because, as “uncorrelated assets,” they tend to do well when equities are tanking and during inflationary times.
Gold, Oil and Buffers
That allure is a key reason why AXA Equitable, New York, offers commodities as an option in a VA unveiled in October: Structured Capital Strategies. The product features a gold index and oil index, as well as S&P 500, Russell 2000 and MSCI EAFE price return indices. The five index funds can be used to design a portfolio distributed among 15 segment types categorized by duration (1-, 3-, and 5-year) and buffer (-10%, -20% and -30%).
Depending on the selected segment buffer, duration and buffer, AXA Equitable will absorb the first 10%, 20% or 30% of any loss in the event of a negative index performance. Conversely, the company also imposes a performance cap rate on the portfolio that may limit the investor’s gain in during an up market.
At the end of each of one-, three- and five-year segment period, investors can also allocate the maturity value of the segment to a new segment. Or they can transfer their gains to other investment options available within the product.
Targeted to clients who are looking for long-term cash accumulation and protection of principle, the VA has generated $125 million in sales since the October launch. And, AXA says, many of the new investors are attracted to the commodity funds.
“About 28% of all IRA participants have elected to put a portion of assets into the gold and oil indices,” says Steve Mabry, AXA’s senior vice president of annuity product development. “And we’re pleased with the client profile: About 20% of the investors are over age 70, 25% are under 55 and the rest are between 55 and 70.”
Investors who can do without the buffers but desire a greater selection of investment choices, adds Mabry, might opt for AXA’s top-selling VA: Retirement Cornerstone. Debuted in January of 2010, the product features dual accounts: one is focused on long-term accumulation and offers 90-plus actively managed funds; the second provides a guaranteed income benefit option that invests in asset allocation and index portfolios to offer downside protection.
The GMIB option also features an adjustable “roll-up” rate that provides an annual percentage increase to the benefit base, enabling the income benefit to grow in a rising interest rate environment.
All well and good. But the investments on offer in AXA’s two VAs come with a mutual fund wrapper. Those clients who want to park assets in exchange-traded funds will need to look to other carriers.
Among them: MetLife. The New York-based carrier offers two “fund of funds, including (1) a Clarion Global Real Estate Portfolio, a fund that normally invests at least 80% of assets in equities of real estate companies; and (2) a Van Eck Global National Resources Portfolio, which invests in oil, gas, solar, gold and coal funds, and other commodities.
The ETFs’ diversified portfolios are not their only distinguishing feature. Elizabeth Forget, a senior vice president for MetLife, says the portfolios offer two key advantages over many actively managed mutual funds. One is reduced cost: Because the ETFs passively replicate a benchmark, they boast lower expense ratios. Also, MetLife’s ETFs are “tactically managed:” Asset allocations are adjusted more frequently than are “strategically managed” mutual funds, thereby allowing asset managers to be more responsive to changing market conditions.
“People are really gravitating to these portfolios; at the end of 2010, we had $2.6 billion in the two ETFs,” says Forget. “Investors are looking for ways to eek out additional returns. And they see these portfolios as being able to provide that.”