Absa’s Optimiser changes equities game

It’s not about outperformance anymore, it’s about avoiding losses.

With cash proving negative real returns investors are turning to equities in pursuit of ever more elusive yield. Given that equities are, however, traditionally volatile and risky, a range of strategies have tried, unsuccessfully, to offer risk averse investors a way of accessing the higher yields potential of equity markets.

Bucking this trend is Absa Bank Ltd’s, member of Barclays, Optimiser series.

“The Optimiser offers risk averse investors – who still need to sleep at night - arguably the most simple, transparent and successful way to maximise equity yield safely,” says Ryan Sydow, Head of Retail Distribution, at Absa’s Corporate and Investment Banking division.

By diversifying into cash when equity markets fall, the Optimiser offers risk-controlled access to equities from a trusted brand through a proven strategy able to manage the volatility and high risk inherent in equity markets.

Based on similar methodology employed in Barclays, the Optimiser offers investors looking for a way into equities, as well as investors already in the market, a way to de-risk their portfolios.

“The Optimiser combines the transparency of passive investments with some of the smarts of active management, but without the costs and unpredictability associated with active management.”

Rising equity markets traditionally exhibit lower levels of volatility or risk. Conversely, when equity markets start falling, volatility increases. The below graph (referencing the FTE/JSE Top 40 Index) shows that volatility is highest when the index is falling – the most pronounced being mid 2008 to 2009, for example.

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The graph clearly shows that one should be in equities in a rising market, and then reduce one’s exposure to equities when the market starts to fall. It also shows that volatility is a reliable (though not perfect) measure to determine whether to be in equities or increase cash.

As such, the idea was to develop a mechanism that keeps investors in equities in a rising market – with the ability to be 150% geared into rising markets - but then automatically de-risks in falling markets with the potential for being 100% in cash.

“The Optimiser achieves this by using an in-built volatility target of 15% which, when reached, reduces risk by diversifying into cash,” explains Sydow.

For example, if the volatility of the Top 40 Index is 15%, then the Optimiser will have 100% exposure to the index. If volatility falls to 12% then equities exposure will increase by 125% (15% Target Vol / 12% Actual Vol). If, however, volatility rises to, say, 20%, then equity exposure decreases by to 75% (15% Target Vol / 20% Actual Vol), allocating the remainder to cash.

The mechanism is ideal for all investors in volatile equity markets. Moreover, since it is rules based there is no room for judgement errors as the rule triggers the protective up-weighting of cash when volatility meets a predetermined level.

While the Optimiser has the potential to outperform the market - as evidenced by its performance since its launch in May 2012 - the real reason to buy the Optimiser is not to outperform the market, but rather to protect your investment in times of high volatility when, generally, markets are falling.

“Only by protecting yourself from drawdowns in times of high volatility can you maximise the risk premium that you receive from being in equities,” says Sydow.

For example, the below graph shows that an investor would be six times richer if they avoided the ALSI’s ten worst months since 1963 – or two and a bit times richer if they had avoided the five worst months over the same period.

“Since it would be almost impossible to time the market to have avoided these months, the Optimiser does the next best thing by adjusting daily - using volatility to automatically judge whether a market is bull or bear,” explains Sydow.

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Up till now the market is in a low volatility environment. As such investors are seeing good performance from equities. The graph below shows that thanks to the gearing effect (up to 150%) in times of low risk the Optimiser is currently outperforming the Top 40 Index. When, however, the correction comes, the Optimiser will reduce its exposure to equities, up-weight cash, minimise losses and protect investors.

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While Absa’s Optimiser is only just turning one, the performance of the Barclay’s six year old Emerging Market Optimiser (EMO) is instructive given the similar strategy employed.

The below graph shows how the emerging markets sell-off from late 2008 to early 2009 saw a peak-to-trough move of 60.7% for the underlying fund - compared to 31.3% for Barclays Optimiser. In other words, the Barclays Optimiser cut volatility, risk and loss in half by providing a more stable growth profile.

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“We look forward to Absa’s Optimiser delivering similar performance and providing similar security to equities investment in South Africa. We expect this to encourage more risk averse investors to get off the cash bench to access the benefit of equities - but with the peace of mind of knowing that the Optimiser strategy will protect them in downturns,” concludes Sydow.