Telstra Super’s internal investment team felt uncomfortable when it observed that a low volatility index did not line up with the fear and volatility that geopolitics was generating in global markets, so it asked its managers’ views. The process enabled the fund not only to be more comfortable with the anomaly, but also to find out which managers were prepared to be true partners.
In its weekly internal investment team meetings, the A$18 billion ($13.3 billion) corporate superannuation fund for telecommunications company Telstra had identified that the Chicago Board Options Exchange Volatility Index [VIX] was unusually low, but no one internally could fully explain how this was happening in a world of expensive assets, numerous geopolitical risks and mountains of global debt.
Telstra Super has a 27 per cent asset allocation to international shares in its default option and as the US equity market is the largest in the world, and arguably the most important, it desired to understand how the anomaly could affect its overseas holdings and asked its external fund managers what they thought.
“We saw that the VIX, which is meant to measure the amount of investor fear and uncertainty, was very, very low – lower than almost ever seen,” Telstra Super chief investment officer Graeme Miller says.
Typically, the higher the VIX – sometimes called the fear index – the more fearful and volatile the markets. However, the index is highly influenced by the actual level of short-term volatility in US equity markets. And in the 90-days to May 8, 2017, the S&P 500 had its most tranquil period in 22 years, with the actual, realised volatility for that time period falling to 6.7 per cent. The preceding months also had low levels of volatility, though not quite at record lows.
The historical high for the VIX was 80.26 points on November 20, 2008, at the height of the global financial crisis. On Monday, May 8, this year, the VIX closed at 9.77 points, indicating extreme market confidence – there have been only three days since the VIX’s inception in 1992 that it has been lower.
‘Swimming without bathers’
Telstra Super has embraced a partnership model with its 60 or so external managers, which handle around 70 per cent of the fund’s assets. It needs them to be more than just an arm’s length executor of a mandate. It wants access to the manager’s intellectual property, ideas, research and insights.
Before joining Telstra, Miller was the head of investment consulting for Australia at Willis Towers Watson, so he knows the breadth of insight that managers possess. For the purpose of uncovering the internal team’s perceived concern about volatility, or the lack of it, he approached a dozen fund managers and gave them a week to give their thoughts on the VIX issue. Some engaged with the question much more fully than others.
“It exposed, to some extent, those that were ‘swimming without bathers’ on the whole partnership thing,” Miller says. “It’s one thing to say, ‘We truly want to be a partner, we truly want to engage with you.’ But [only] some of them thought deeply about this, really brought the full weight of the organisation to the problem and came back to us with well-thought through answers.”
Miller won’t disclose the specific managers tapped for insights, but says they were selected from each of the super fund’s asset classes to garner a wide variety of views.
He adds that although there was a broad range of managers there was a surprising level of consistency in the responses.
Three of the key observations were:
- While overall market volatility was low, intra-sector correlations were unusually high following US President Trump’s election. For example, the value of the US utilities sector had dropped, but the US defence sector had risen in value; this was masked by a low volatility in the overall market.
- Because volatility was based on the spread between implied and realised volatility, it could be argued that the VIX was a lagging, not a leading, indicator.
- No manager thought the US was on the precipice of a major market downturn, although there was a sense that there was some complacency about the systemic risks in the market.
Insights breed confidence that gets rewarded
Armed with the insights from the selection of managers, the super fund’s 16-person internal team was more confident about implementing actions in response to the disconnect between the short-term risks reflected in the ‘fear index’ and longer-term risks in global markets.
“The fact that markets, as a whole, do not think we are on the precipice of a major downturn gave us confidence to maintain a full exposure to growth assets over the past few months – and we’ve been rewarded for that,” Miller says. The fund’s allocation to growth asset is about 69 per cent for its balanced fund, across domestic and international equities, property and infrastructure.
He adds that the insights drove home to the internal team the point that the VIX is a blunt tool and was not an especially reliable indicator of investor sentiment or risk.
“This allowed us to more confidently position the portfolio towards a full weight to growth assets, coming from a position where our natural bias would have been to be a bit more cautious.”
The success of the approach has emboldened the Telstra Super investment team to reach out to fund managers for their views on market issues more often. And it’s worked both ways. One of the managers felt empowered to come to the super fund with a new idea.
“It has signalled to our fund managers [that we want insights]. It has given them a much deeper understanding of what we are interested in and what we are worried about,” Miller says.