Crises the ultimate test for investment risk management
07 September 2020
5
min read
Financial markets are always evolving. As new information is discovered, expectations for the future are revised and reflected through upward or downward price changes. Price volatility creates both investment opportunities and risks.
To capture the opportunities while minimising the risks, QSuper’s Investments team uses dynamic asset allocation (DAA).
QSuper’s DAA process is founded on a belief that all financial assets are anchored to a fundamental value, and that any differences between this value and the current market price will be eliminated over time. DAA involves buying assets whose prices have fallen and selling assets whose prices have risen.
Discipline required to be dynamic
The biggest challenge to implementing DAA is staying the course. As prices move above their fundamental value, some market commentators argue that the good times will never end and criticise sellers for leaving money on the table. Conversely, when markets are in freefall and negative sentiment abounds, some experts advocate selling before things get worse or simply wait for signs of a recovery.
Under normal market conditions, DAA instructions are rare, because it takes time for prices to drift far enough away from fundamental values. As market volatility increases, so too does the frequency of instructions. We can see how many DAA instructions the QSuper Investments team issued since 2011:
Number of DAA decisions issued by QSuper Investments
Monthly, since 2011
Over the decade, the team averaged five decisions a month, but market conditions in March 2020 were so extreme that it issued more than one instruction every day, for a total of 38.
This graph is indicative only.
A 2020 perspective
Crises are the ultimate test for risk management processes like DAA, but fortunately, they don’t happen very often. In fact, until the onset of the COVID-19 pandemic, financial markets hadn’t experienced an event of that size and scope since the global financial crisis in 2008-09.
Leading into March 2020, QSuper had moved to a position with fewer equities in our default and diversified investment options and more fixed interest. Why? We had anticipated that when share markets corrected, investors would push government bond prices higher in their search for a safe haven. Our foreign currency exposure was also higher than normal, enabling the options to benefit from any selloff in the Australian dollar.
As share prices fell, QSuper’s Investments team bought more. With fixed interest, the team did the opposite, progressively selling as bond prices reached new highs. In the foreign exchange market, the Australian dollar weakened, inflating the value of offshore holdings and freeing up cash for reinvestment.
Investing with confidence
The DAA process performed exactly as expected, with the benefits flowing directly into unit prices. By implementing DAA in combination with our risk-balanced investment strategy, QSuper can deliver a return experience with fewer ups and downs. This helps give members more confidence when making decisions that affect their financial wellbeing.