Kan says that in addition, “as a last line, these [products] are provided by a life company, and a life company has to provide capital to back those guarantees, and that’s taking into account the fact that there is a hedge program”.
“To the extent that there’s any ineffectiveness in that, that’s what the life company does: provides capital in order to make good on the guarantee in the long run,” he says.
Kan says the instrument the product provider uses to hedge its liability to investors “depends on what the market risk is”.
“Broadly speaking, there are futures available, there are options available,” he says.
“You can use different instruments to hedge different risks, swaps, depending on whether it’s specifically market risk, the level of indices, interest rate risk or volatility risk.
“In MoneyForLife there are three diversified investment portfolios. They are fixed asset allocation; they’re all index-managed within the actual asset class – so, for example, the Australian equities component will be managed to track the index.
“The international equities component – there is in each of them a different proportion – that’s currency-hedged within the fund, so that’s something that’s managed within the fund.
“The risk depends on the individual asset class. If you look at the fixed interest component, that’s all invested in Australian Government bonds, so the credit risk related to that is minuscule. But there is still interest rate risk in relation to that. And in the equities component there is market risk in relation to that.
“We use different instruments depending on the duration of the risk.
“There’s a liability we have. It’s like two sides of the balance sheet: there’s an asset side and a liability side. The liability side is the obligation we have to pay out to investors, and the asset side is basically our hedge position. Then we use various instruments…to neutralise the effect of market movements on those liabilities. So we try to have an asset-liability match.”
Kan says it’s important to understand there are two components to the mechanism by which an income or a sum of capital is guaranteed.
“Let’s be quite clear,” he says. “The underlying assets that the investor has, they will invest with us, and we will put their money into underlying investment funds. The value of those investment funds will rise and fall with the markets. What we then do is have a separate statutory fund, which we basically manage around to offset the fact of what’s happening.
“[The net effect of that] is to match at all times as closely as possible the asset position that we have, either in terms of the actual underlying assets – which are the funds held by the investors – or the hedge position against the liabilities.
“We actively rebalance; we do not just set and- forget. We don’t just take a hedge position and say that’s it; we rebalance that hedge position. It’s active. It’s active within bounds. If the market is very volatile it will be more active, and if the market is less volatile, and more stable, it will be less active.
“The guarantee [cost] varies between 110 and 140 basis points, depending on the actual underlying mix of the assets. If they have got more growth assets, the cost of hedging that is higher than if there’s a lower proportion of growth assets.
“You choose your underlying investment blend, and then the cost of hedging that [asset mix] is higher or lower, depending on that.”
AXA’s Emery says products like North have been tried and well tested in developed markets, particularly in the US. And the systems and strategies behind North have been extensively back-tested.
“The beauty of being part of the global AXA group is that they’ve been running these products for a number of years – in the US, at least 15 years,” Emery says.
He says that period has encompassed both good and bad markets.
“In the US, they had the tech wreck,” he says. “The US would have been through more volatility cycles than we have.”
He says the products held up well even when volatility was extreme.
“We would not be pushing it if it hadn’t held up OK.”
