Insurance companies, grappling with the growing challenge of market timing activity in their variable annuity sub-accounts, are taking a conciliatory approach compared with that many mutual fund companies have adopted towards market timers.
Insurers face a dilemma. Insurance companies want to provide enough flexibility to brokers and other advisors so that they can shift client money between investment sub-accounts as they deem necessary. Investment managers, charged with investing the assets held in variable annuity sub-accounts, are not opposed to variable annuity providers offering that flexibility.
But when excessive trading in and out of variable annuity sub-accounts occurs, both sides get frustrated. In many cases, managers are forced to sell securities to meet sizeable redemptions, and then must rush to reinvest those same assets when they come back into the fund a few days later. Fund expenses related to an increased volume of trades can quickly drag down performance. And, assets repeatedly moving in and out of a fund can seriously disrupt a fund manager's investment strategy, say industry executives.
Some insurance companies and money managers have seen increased movement by market timers since the stock market has fallen, say industry executives.
"The activity has increased," said Michael Butler, senior vice president of NFS Distributors, a division of Nationwide Life Insurance Company of Columbus, Ohio. "Lots of money is going back and forth trying to jump on trends and sectors of the market not having difficulties."
Variable annuity companies are taking a variety of tacks to cope with market timers. Some are building roadblocks to prevent quick money movements. In July, TIAA-CREF, the pension and annuity manager in New York, made more stringent its rules on transferring assets between its variable annuity sub-accounts. It imposed a two transfer limit on assets leaving its International Equity Account during any 90-day period, and restricted transfers from its fixed investment accounts into its variable investment accounts to one transfer every 180 days. The message is clear that quick movements are not welcome, said Tom Pinto, a TIAA-CREF spokesperson.
Other variable annuity providers have opted to build special products or offer special investment options that will give market timers the freedom they want while leaving other variable annuity investment accounts relatively unhurt.
Nationwide will begin offering a new, as yet unnamed, variable annuity product in the fall which will cater to the needs of market timers, said Butler. The investment sub-accounts offered under the new Nationwide annuity would include 20 different funds managed by RYDEX Funds of Rockville, Md. Market timers have long appreciated RYDEX because the fund group first introduced mutual funds that cater to market timers' rapid shifting of assets.
In addition to offering many RYDEX investment options, Nationwide will offer several more traditional buy and hold funds that will be multi-managed by well-known investment firms, Butler said. The more traditional funds will also be accessible to market timers who want to, for instance, sideline assets for awhile or longer term.
But Nationwide plans to make it clear to market timers through the imposition of strict transfer provisions as well as redemption fees on the non-RYDEX Funds, that frequent trading will only be allowed within the RYDEX investment accounts, said Butler. It has not yet decided on the magnitude of the fees or the exact transfer provisions.
"We're trying to give them the alternative," said Butler.
The new annuity product was developed after focus group were held with market timers and those that consider themselves strategic asset allocators, Butler said. Nationwide wanted to understand just what these timers wanted from it, he said.
"Now we will have a place where we can say, Hey, this will better suit your needs,'" Butler said.
Others in the industry are seeking to understand why market timer shifts are a problem for portfolio managers and what can be done to minimize the impact of timers on investment managers and their funds.
Part of the problem lies in the basic operational structure of mutual funds, said Bill Zink, director of structured investments at PanAgora Asset Management in Boston. PanAgora is an institutional asset manager co-owned by Putnam Investments, also of Boston, and Nippon Life Insurance Company of Osaka, Japan. As funds are structured, with their 4:00 p.m. trade cut offs and subsequent calculation of the funds' net asset values, the value of the fund may differ from what it would be based on the prices received by sellers making trades at the end of the day.
A fund manager will usually not see a cash report on how much money was added to or redeemed from a fund until the day following an actual trade. A $20 million fund redemption request that comes in from a market timer late in the day cannot be acted upon by the fund manager until the following day, said Zink. Then the fund manager must sell an equal amount of securities to realize enough cash to fulfill that $20 million redemption request. But if the stock market has dropped in the interim, the fund loses by having to pay for the difference, Zink said. If there are lots of market timers, the flows can be substantial and can adversely affect the fund.
To prevent this, fund advisers can set an earlier but still reasonable deadline, say 3:00 p.m., by which market timers must have their trades in, said Zink. Then portfolio managers can sell sufficient securities that same day.
High securities trading costs are another problem asset managers often face when timers make frequent trips in and out of funds. Costs can be significantly higher in the small cap or international markets, said Zink. While the cost of a single trade is minimal, large trading costs add up very quickly, Zink said.
To alleviate this, portfolio managers can maintain a small cash cushion and invest another small portion of the fund in stock index futures, he said. Stock index futures offer managers just as much liquidity as cash and is less expensive.