The recent bout of stock market volatility is putting a new variable annuity investment strategy to the test.
So-called tactical-asset-allocation programs, which aim to limit volatility by moving in and out of fixed income as the stock market fluctuates, are a fairly new development in the world of VAs. Prudential Financial Inc. popularized the concept among VA providers when it started the strategy in 2006.
But after the market downturn in 2008, other insurers also began offering such programs in an effort to shield their VA accounts from dramatic fluctuations in the market. That's because volatility raises hedging costs for insurers, a painful lesson many insurers learned in 2008 and 2009.
Axa Equitable Life Insurance Co., MetLife Inc., Ohio National Financial Services Inc. and Sun Life Financial Inc., for example, all have unveiled tactical-asset-allocation programs over the last few months.
Transamerica Life Insurance Co. began using such programs in its VA lineup about a year ago.
Money managers who are bringing their tactical-asset-allocation strategies to insurers via an underlying VA investment options include AllianceBernstein LP, AQR Capital Management, BlackRock Inc. and ValMark Advisers Inc.
Some advisers are skeptical of VA providers' use of tactical-asset-allocation programs.
“They don't have any track records,” said Stephen Esposito, an adviser with Macro Consulting Group, which just recently began using a MetLife variable annuity that employs a tactical strategy.
Kevin VanDyke, president of Bloomfield Hills Financial, worries about the strategy's lack of transparency.
“From my understanding, the managers aren't going to say exactly what's in cash, stocks or bonds,” he said. “They'll tell you it's 50% equities and 50% bonds, but when the [volatility index] is high, they move to cash.”
AllianceBernstein informs insurers about its portfolio changes but leaves it up to the insurers to share that information with advisers, said Mark Hamilton, investment director of Dynamic Asset Allocation at AllianceBernstein.
Other advisers avoid using tactical-asset-allocation programs because they prefer to call the shots themselves on how their clients' VAs are invested.
“At first, I thought, "I'm the broker, and I'm the one who's investing; you can't use your formula,'” said Richard D. Brandhorst, an adviser with FSB Warner Financial Inc.
He has been won over.
“I don't question quite as much,” Mr. Brandhorst said. “Getting out [of the market] is becoming as important as getting in.”
By and large, VAs using tactical-asset-allocation programs have been behaving as expected during the market's recent bout of volatility, advisers said.
“Your account will go down, but not as much as you would have in other investments,” said Marc Silverman, an adviser with Silverman Financial Inc.
Mr. Silverman noted that his Prudential clients saw their accounts dip by about 7.5% during this month's volatility. He estimated about 20% of his clients' VA assets in the insurer's program moved into Prudential's bond portfolio during the most tumultuous period.
Mr. VanDyke also is pleased — so far — with the performance of BlackRock's and AllianceBernstein's portfolios, both of which are investment options in a MetLife VA that he uses. The AllianceBernstein and BlackRock portfolios fell 3.2% and 4.5%, respectively, between June 30 and Aug. 23, compared with 11% for the S&P 500.
AllianceBernstein's Dynamic Asset Allocation program was down by 4.1% for the one-month period through Aug. 23, while the S&P 500 was down 10.05%. The strategy's benchmark typically is a 60% equity and 40% fixed-income blended portfolio, which lost 5.6% during the one-month period.
ValMark's strategy, which is spread across three portfolios that vary by risk, reported similar results. The firm uses exchange-traded funds, futures contracts and put options as a way to hedge within the VA subaccount, thus dampening market volatility.
One-month trailing results as of Aug. 19 show that ValMark's TOPS Protected Growth ETF portfolio was down 4.77%, while its Protected Moderate Growth and Protected Balance ETF portfolios were down 3.74% and 2.57%, respectively, according to Michael McClary, ValMark's chief investment officer.
The S&P 500 was down nearly 14% over the same period.
Prudential's model is different in that it uses an algorithm to adjust the amount of money going into bonds. Bond transfer varies in amount, depending on various characteristics of the account holder, including how long the client has been invested with Prudential and the performance of the individual account, said Bruce Ferris, executive vice president of sales and distribution at Prudential Annuities.
Experts believe that tactical asset allocation will become more widespread among insurers offering variable annuities. “If not all of them, then a lot of them” will begin using the strategy, said Tamiko Toland, managing director for retirement income consulting at Strategic Insight.
“Starting out, it's very much a risk management strategy, but it will be more accepted as another tool in the toolbox for investment management,” she added.
dmercado@investmentnews.com
