The value of using a capped volatility investment strategy – case study

by Patrick Norwood
Insight Analyst - Funds

January 2015

Life expectancy is increasing and adviser clients will require sustainability of both income and capital with their retirement funds. While this case study acknowledges that product selection to support this strategy for the client is extremely important, it explores what the underlying investments do for returns and the protection of client funds.

This is all the more important considering the likely decline in the use of ‘lifestyling’, and the increasing tendency for clients to remain invested in a drawdown contract following recent legislation changes.

The focus of this case study is on funds which aim to deliver decent returns while providing capital protection. In the past, clients approaching retirement had basically two choices. They could either stay invested, usually with the majority of their fund in the stock market, or use one of these two very similar strategies: 1) de-risking their investments (switching to lower risk assets) or 2) lifestyling.

The benefits and risks vary

The advantage of staying invested is that exposure is maintained to equities, which have historically provided the best returns over the long term. However, equities have also been one of the most volatile asset classes and have seen some big falls in recent years.

Even if the fund is diversified, it may not be protected from a market shock. In the dotcom crash, for example, while equities fell heavily, the other main asset classes provided positive returns, so diversified funds would have fallen a lot less.

Following the recent credit crisis, though, almost all asset classes declined in value, apart from high-quality government bonds. In this case, even a well-diversified portfolio would have suffered big losses.

When de-risking/lifestyling, the risk of a fund suffering from any market shocks is reduced as the fund is moved out of equities and into fixed interest. There are, however, a few disadvantages to this approach: Missing out on the growth potential of equities, market-timing, and being dependent on retirement at a certain date.

To provide you with a benchmark of the volatility-capped alternative, we have analysed AllianceBernstein's funds in more detail. It should be noted, however, that while these types of fund generally provide downside protection as well as maintaining decent returns, the upside is also capped, meaning that investors in them won’t fully participate in any strong and sustained equity ‘bull-market’.