Managed Risk Funds Can Align With Retirees’ Needs | American Funds

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American Funds Insurance Series

January 2017

Managed Risk Funds Can Align With the Needs of Retirement Investors

Traditional actively managed funds are often a good choice for investors with long time horizons and the confidence to stay invested. A diversified investment mix that includes traditional funds can offer an attractive longer term risk-adjusted return potential.

Even so, we recognize that limiting the volatility of returns and preserving assets may be high priorities for investors who are:

  • Risk averse
  • Near, or in, retirement
  • Drawing on investment income

For these investors, we have created a diverse set of investment options: American Funds Insurance Series (AFIS) managed risk funds.

The AFIS managed risk funds invest in shares of traditional AFIS funds and employ a risk management overlay ― the AFIS managed risk strategy.

The overlay consists of two elements that offer complementary sources of potential risk management:

  • Volatility management seeks to control the volatility of investment returns as market conditions change.
  • Capital protection strives to help preserve capital in certain stock market declines.

AFIS managed risk funds may be worth considering if you seek potential safeguards beyond the potential risk mitigation offered by diversified and actively managed mutual funds.

Many Investors May Experience Greater Short-Term Volatility Than They Expect

Volatility of a Hypothetical Balanced Portfolio of 60% Stocks and 40% Bonds*

*Longer term volatility measured over the full 20-year period from June 30, 1996, to June 30, 2016. Shorter term volatility calculated using all full monthly rolling three-year periods within the 20-year period. Hypothetical 60/40 portfolio represented by Standard & Poor’s 500 Composite Index and Bloomberg Barclays U.S. Aggregate Index1, respectively; the portfolio blends the indexes by weighting their total returns at 60% and 40%, respectively, and assumes that the blend is rebalanced monthly. Volatility is calculated using annualized standard deviation (based on monthly returns), a measure of how returns have varied from the mean; a lower number signifies lower volatility. Investors cannot invest directly in indexes.

Bloomberg Barclays U.S. Aggregate Index represents the U.S. investment-grade fixed-rate bond market and consists of U.S. Treasury and government-related bonds, corporate securities and asset-backed securities. Standard & Poor’s 500 Composite Index is a market capitalization-weighted index based on the results of 500 widely held common stocks.

Sources for index information: Bloomberg Index Services Ltd. and Standard & Poor’s. Standard & Poor’s 500 Composite Index℠ and S&P 500® are service/trademarks owned by The McGraw-Hill Companies, Inc.

An Investment Approach Designed to Limit Losses May Reduce Sequence of Returns Risk

The math of compounding is powerful. It’s the reason that slight changes in interest rates dramatically affect the cost of an adjustable rate mortgage over 30 years. It also explains how an active manager that consistently outpaces an index by a little each year can generate a superior return over a decade or two.

Unfortunately, when you’re drawing income from an investment, a similar effect can derail your plans. Because of compounding, investment losses combined with withdrawals may quickly deplete a portfolio. A cluster of negative annual returns early in retirement, for instance, could cause an investor to exhaust his or her wealth as losses and withdrawals lead to rapidly dwindling assets.

Conversely, another retiree who recorded the same average return over their retirement but encountered those same losses later on could enjoy a perfectly comfortable retirement.

In other words, the sequence in which returns occur can have a dramatic effect on investment outcomes.

Clearly, an investment approach that seeks to offer results that exchange some upside for a limited downside could be beneficial. Experiencing consistently smaller losses can be effective in reducing sequence-of-returns risk, which can help maintain a larger base of assets that may support withdrawals for longer.

Do You Need Your Investments to Sustain Withdrawals? If so, It’s Important to Know That Untimely Losses May Put Your Plans at Risk.

Values of a Hypothetical $100,000 Investment Over 10 Years, Including Annual Withdrawals

These examples are hypothetical. Results are for illustrative purposes only and in no way represent the actual results of a specific investment. Initial investment of $100,000. Withdrawal of $5,000 at end of first year; dollar amount withdrawn at each subsequent year-end increases by 3% annually. Total amount of withdrawals is $57,319.40.

AFIS Managed Risk Funds Are Designed for Investors Who Want Funds That Seek to Reduce the Impact of Stock Market Volatility and Declines on Investment Returns

The managed risk strategy used within each AFIS managed risk fund is an overlay that is based on certain characteristics of the underlying traditional AFIS fund’s portfolio. Designed to work together, each element of the overlay uses exchange-traded futures contracts to create varying financial exposures.

Volatility Management

The strategy seeks to responsively reduce equity exposure when market volatility exceeds a fund-specific threshold.

Often, there have been extended periods when market volatility was elevated and other times when it was subdued. That suggests it may be possible to anticipate volatility’s near-term ebb and flow by assessing current market conditions.

With that in mind, our managed risk strategy constantly monitors and analyzes market data, gleaning information that we believe helps us to deliver responsive risk management.

If volatility increases beyond a fund-specific threshold, futures contracts are used to reduce equity exposure.

When markets stabilize, holdings of futures contracts are adjusted to restore equity exposure.

Capital Protection

The strategy seeks to provide fund investors with an additional source of capital protection in declining markets.

Because market declines can occur without a preceding uptick in volatility, our managed risk strategy takes risk management a step further.

Futures contracts are used to create an offsetting equity exposure whose value should increase if the fund’s value declines below a specified level.

This “protection level” is periodically reset (by adjusting holdings of futures contracts) as the fund’s value changes.

In a declining market ― if the fund’s value drops significantly below the protection level ― the level is lowered to match the current fund value.

  • Resetting to a lower protection level allows fund investors greater equity exposure, which should be helpful in a subsequent market rally.
  • For new investors, the reset means that the downside protection should be closer to the current fund value.

In a rising market ― if the fund’s value significantly exceeds the current protection level ― the level will be raised to match the current fund value.

  • Resetting to a higher protection level should help protect gains for existing investors. 
  • For new investors, the reset means that the downside protection should be closer to the current fund value.

Futures contracts are exchange-traded financial instruments that represent an obligation between buyer and seller to exchange cash flows based on the movement of an underlying asset such as a market index. Futures contracts may not provide an effective hedge of the underlying securities because changes in the prices of futures contracts may not track those of the securities they are intended to hedge. In addition, the managed risk strategy may not effectively protect the fund from market declines and will limit the fund’s participation in market gains. The use of the managed risk strategy could cause an AFIS managed risk fund’s return to lag that of the underlying fund(s) in certain rising market conditions.

Complementing AFIS’s Consistent Investment Approach With Milliman’s Risk Management Overlay Experience

The managed risk strategy within AFIS managed risk funds is designed to offer investors greater confidence about shorter term results. It is managed by a subadviser, Milliman Financial Risk Management LLC, a leading provider of risk management services to the life insurance industry. As of July 2016, Milliman provided investment advisory hedging and consulting services on $166 billion in global assets.

Risk: Monitor It Constantly, Manage It Responsively

Each element of our managed risk strategy has a distinct aim. Volatility management seeks to responsively limit the volatility of investment returns as market conditions change. Meanwhile, the goal of the capital protection element is to preserve capital in a down market.

Though each element’s focus in terms of risk mitigation is different, they are designed to work in tandem. In periods of low market volatility the futures contracts held within the volatility management and capital protection elements may create offsetting exposures.

Importantly, our managed risk strategy is designed so that it will never be net long futures contracts. In other words, the strategy is constrained so that it shouldn’t add to the investment risk taken by the underlying traditional AFIS fund.

And, regardless of the market environment, each AFIS managed risk fund maintains a cash holding to support its managed risk strategy.

AFIS managed risk funds do not try to time short-term market moves. Rather, they’re designed to limit losses in down markets.

AFIS Managed Risk Funds Are Designed to Offer Potential Results That Exchange Some Upside for Lower Volatility and a Limited Downside Compared to Traditionally Managed Equity Funds

Over time, a portfolio that is heavily invested in stocks is likely to experience returns characterized by infrequent highly negative losses that are not completely offset by highly positive gains (gray line below).

For illustrative purposes only and does not portray the results of an actual investment. Your experience may differ.

Managed Risk Strategies Can Combine With a Broad Range of Investment Objectives

AFIS managed risk funds do not eliminate returns volatility or sequence-of-returns risk, but they are specifically designed for investors who would like to reduce these risks. We view these funds as a continuation of our commitment to being aligned with investor success.

We offer five managed risk funds focused on growth, growth and income, high-quality stocks, international stocks or a balance of stocks and bonds. Each fund consists of an underlying AFIS fund and the managed risk strategy overlay.

Additionally, our American Funds Insurance Series ― Portfolio Series℠ features three objective-based managed risk funds, each of which invests in select underlying AFIS funds and includes a managed risk strategy overlay. The AFIS Portfolio Series managed risk funds are structured according to balance or appreciation, depending on objective.

Managed risk funds portfolio managers/ Years of experience*
Alan Berro 30
James Mulally 40

Subadviser portfolio manager/ Years of experience*
Adam Schenck 11
Milliman Financial Risk Management

*As of May 2016

1Bloomberg® is a trademark of Bloomberg Finance L.P. (collectively with its affiliates, “Bloomberg”). Barclays® is a trademark of Barclays Bank Plc (collectively with its affiliates, “Barclays”), used under license. Neither Bloomberg nor Barclays approves or endorses this material, guarantees the accuracy or completeness of any information herein and, to the maximum extent allowed by law, neither shall have any liability or responsibility for injury or damages arising in connection therewith.

Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.

This material is intended for use by financial professionals or in conjunction with the advice of a financial professional.

Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses, which can be obtained from a financial professional and should be read carefully before investing. 

The return of principal for bond funds and for funds with significant underlying bond holdings is not guaranteed. Fund shares are subject to the same interest rate, inflation and credit risks associated with the underlying bond holdings. Lower rated bonds are subject to greater fluctuations in value and risk of loss of income and principal than higher rated bonds. 

Investing outside the United States involves risks, such as currency fluctuations, periods of illiquidity and price volatility, as more fully described in the prospectus. These risks may be heightened in connection with investments in developing countries. 

Futures contracts may not provide an effective hedge of the underlying securities because changes in the prices of futures contracts may not track those of the securities they are intended to hedge. In addition, the managed risk strategy may not effectively protect the fund from market declines and will limit the fund's participation in market gains. The use of the managed risk strategy could cause the fund's return to lag that of the underlying fund in certain rising market conditions.

Past results are not predictive of results in future periods.