Case study of Magellan FuturePay
Magellan Financial Group has just launched a new listed actively managed fund that is designed to deliver investors a regular monthly income, with a focus on downside protection, called FuturePay.
It is part of a long-term strategy which began in earnest back in 2017 when the fund manager hired Paddy McCrudden to look at the risk, and opportunities, that investors face when they move into retirement phase.
McCrudden responded to questions from Industry Moves on the product’s unique construction and how it came into being.
How did this fund come about?
In around 2016, Magellan started thinking about the opportunities and risks as investors move from accumulation to decumulation. In 2017, Brett Cairns, then executive chairman, hired Paddy McCrudden to focus on this problem. The initial research explored the needs in retirement, the compromises that investors were making, and how they were making progress towards a solution. After developing a concept to meet retirement needs, the team refined, optimized and stress tested the ideas over several years.
Do you think there is anything like it currently available to Australian investors?
Given the importance of assisting retirees meet their financial needs, many asset managers have focused on developing products in this space. Whilst several of these products have characteristics in common with FuturePay, no other solution combines all the key features of FuturePay in a single product. For example, some products invest in growth assets and deliver a fixed income, but don’t have explicit reserving capabilities for risk management. Other products, such as annuities, provide a fixed monthly income, but don’t provide ready access to capital.
What is the role of data science in managing this fund?
Whilst data science is not explicitly used in the day-to-day management of the fund, we used machine learning techniques extensively to find reserve strategies that provided optimal outcomes for investors over the long run.
What represents the biggest risk to the fund?
The fund is designed provide investors with predictable, monthly distributions that grow with inflation, while reducing the risk of permanent capital loss. To deliver this, our underlying investment strategy should deliver returns greater than, or equal to, inflation after delivering that income over the long run.
Whilst the underlying investment strategies have handily exceeded this target historically, the biggest risk to the fund is a sustained period of equity market underperformance – think the lost decade in Japan. The high quality, low volatility approach to investment and introduction of the Support Trust aim to mitigate this risk.
Can you explain the role of the Support Trust and MFG Reserve Facility?
While the intuition of putting something aside in good times for an inevitable ‘rainy day’ may not be new, it is a powerful and effective insight into how to manage risk.
Sequencing risk hits hard in periods of poor performance in investment markets if assets need to be sold to fund regular income.
Setting aside assets or reserving some of the gains made from investment assets when they outperform, and drawing upon those reserves to support income when investment markets inevitably fall, can mitigate the need to sell growth assets in poorly performing markets.
However, the challenge in implementing an effective reserving strategy is knowing exactly how much of your investment assets to set aside as a reserve, when to add to them and when to use them.
FuturePay has a reserving process embedded into the product itself. FuturePay will make regular contributions to the Support Trust, a separate pool of assets managed for the benefit of FuturePay investors. The Support Trust is designed to provide potential income support to FuturePay during poor market conditions.
The Support Trust will be initially capitalised by Magellan. It will also receive a small contribution from FuturePay when FuturePay issues new units and when FuturePay has outperformed the inflation adjusted index after making distribution payments. Conversely, if FuturePay underperforms the inflation adjusted index, the Support Trust may provide payments to FuturePay to support distribution. Such payments mitigate the need to sell growth assets when they have fallen, thus reducing the impact of sequencing risk.
The pooling of reserves with other investors through the Support Trust also makes the process more efficient by reducing the level of reserves required. Reserving as an individual can be effective, however, on average you will typically need to set aside a larger proportion of your savings as reserves which can result in a drag on investment performance that impairs total investment returns.
The MFG reserve facility plays a similar but smaller role. In specific circumstances, FuturePay has the ability (but not obligation) to borrow additional funds from Magellan Group to support the Fund in paying the distributions to investors.
Together, the Support Trust and MFG Reserve Facility assist FuturePay in delivering its objective of providing investors with a predictable and growing monthly income stream, while reducing the risk of permanent capital loss.
Can you explain how you come up with the fee structure for this fund?
The fee structure is very simple – it is flat 1 per cent. There is no performance fee.