An interview with Greg Campbell
Greg Campbell, Challenger’s Senior Portfolio Manager, Asset Liability Management, answers commonly asked questions about Challenger Index Plus (Index Plus). Breaking down how the capability works, why it’s so popular amongst super funds today and the way risk is mitigated.
- How does Index Plus work?
Index Plus is a simple and innovative solution that offers institutional investors contractual alpha over an agreed index, with zero management fees. Investors have the flexibility to choose from a range of investment terms, collateral profiles and indices. Index Plus can be used either as an effective substitute for traditional passive funds, or as a complementary solution to active management. By offering an excess return over an index, this product can have a substantial impact on realised total returns. It can also assist institutional investors in managing (or reducing) their overall fee budget.
- How is counterparty risk managed?
Returns comprising the performance of the selected index and agreed alpha are guaranteed by Challenger Life Company (CLC) and gives rise to counterparty risk. However, this risk is mitigated by the fact that CLC is, an APRA-regulated life insurance company and is required to maintain prescribed capital levels based on its investment and liability profile. In practice CLC maintains capital ratios in excess of this requirement, targeting levels of 1.6 times the prescribed minimum amount.
CLC’s strong capital position and regulatory oversight provides investors comfort that CLC will be able to meet its obligations to investors now and in the future.
- What super funds are currently invested in Index Plus?
We have seen very strong growth in the number of clients using our Index Plus capability. As at November 2021, we had clients invested in Index Plus from retail multi-manager funds, profit-for-member funds, and other institutional investors. We see three common themes across clients that use Index Plus:
• Desire for certainty: investors take great comfort in the fact that the Index Plus alpha is contractually assured.
• Desire for low fees: Index Plus allows our clients to reduce their fee cost base without compromising returns.
• Zero tracking error: the added benefit of receiving contractual returns from Index Plus is that they come with zero tracking error. This is an added benefit to investors that wish to minimise their excess return volatility.
- Why is this type of investment vehicle and strategy growing in popularity?
With the current pressure on fees and the roll out of the Your Future Your Super (YFYS) performance test, super funds are increasingly focussed on low-cost investment exposures that meet the requirements of the YFYS benchmarking framework. There is also a growing focus from investors to reduce the basis risk between their current benchmarks and the benchmarks assumed in the YFYS performance measure. Index Plus offers investors the ability to gain the desired benchmark exposure while capturing a contractual margin over the index for zero fees. This provides investors with greater flexibility in managing their fee budget whilst being assured of outperforming the index. These themes position Challenger’s Index Plus proposition in a very compelling light.
- What indices do you use?
CLC can offer a wide array of indices where the underlying index exposures can be cost-effectively hedged through total return swaps, futures, or in certain circumstances by holding securities comprising the underlying index.
The alpha that CLC pays over the index is adjusted to reflect the cost of hedging. This makes certain indices more or less attractive in practice. CLC offers the following indices as standard options (with other indices considered on request):
• AusBond Bank Bill Index
• RBA Cash Rate Index
• AusBond Government Index
• AusBond Treasury Index
• AusBond Government Inflation Index
• AusBond Government Index
• MSCI World Ex-Australia Index
• MSCI ACWI
- Can alpha levels be sustained as funds under management grow?
The traditional approach to generating alpha relies on active management through security selection and timing. This is hard to do consistently, particularly for larger portfolios where the market impact of active management can lead to higher costs.
In contrast, CLC generates the agreed alphas by aligning investments with the broader CLC balance sheet. Index performance is hedged, allowing CLC to effectively lock-in a fixed margin over swap rates.
The investment of funds at investment margins in excess of funding margins generates alpha in a scalable manner and is not impacted by the potential crowding-out of returns from active strategies.