The market recovery since 2008 has been dramatic, with the S&P 500 reaching new highs. Corporate balance sheets have been significantly improved, with bottom-line earnings continuing to beat street estimates. The Federal Reserve continues to provide liquidity into the financial system through quantitative easing. Housing is improving and jobs are slowly recovering. Yet, investors remain tepid, at best, at participating in this rally. Trillions of dollars remain on the sideline, with the memories of the market sell-off in 2001 and 2008 fresh in their minds and evaporating the savings of many approaching retirement.
In addition, the markets have demonstrated increased volatility over the last several years, with wider swings in the markets, even as the market trends upward. Furthermore, clients see what is happening around them: family and/or neighbors are unemployed, global instability is ever-present, food and gas prices continue to rise, and growth in the global economy remains slow. Investors are seeking solutions to their fears of the market and the need for lasting retirement income. One potential solution is today’s variable annuities, which allow individuals and couples to participate in the market with guaranteed minimum income that will not run out.
Let’s take a look at how investors can manage the volatility of their investments within these annuities and how insurance companies manage risks associated with these income solutions.
What can you do for your clients?
Diversify through asset allocation. Asset allocation is an investment strategy that aims to balance risk and reward according to an individual’s goals, risk tolerance and investment horizon. As demonstrated in the below chart, asset allocation has evolved over the years, with Modern Portfolio Theory, or MPT, one of the earliest theories of diversification between asset classes. Then the Capital Asset Pricing Model, CAPM, and Black Scholes models introduced the measurement of risk to a portfolio.
Today’s more sophisticated portfolios utilize non-traditional (or alternative) asset classes and strategies. Although newer to the retail investors, endowments, institutions and wealthier investors have been incorporating these strategies for decades. Examples of these alternative investments include real return strategies, such as REITs, TIPs, commodities and global infrastructure. In addition, absolute return strategies are utilized, such as market neutral, currency trading and diversified arbitrage. By combining alternative asset classes with traditional equities and fixed income, the portfolio’s volatility may be dampened further.
Keep in mind, however, that asset allocation does not guarantee a profit or protect against a loss. Application of diversification does not ensure safety of principal or interest. It is possible to lose money by investing in securities.
How are variable annuity companies managing risk?