Wall Street is pointing the finger at insurance companies as an unlikely but pivotal source of the turbulence that wiped trillions of dollars off stock market values in recent days.
While complex volatility-linked funds and algorithmic traders have been widely blamed for the wild price swings, strategists and investors said a significant portion of the selling could be traced to variable annuities, a popular tax-advantaged insurance-company product that offers customers guaranteed returns.
US life insurers suffered losses on variable annuities in the financial crisis. Since then, insurers have responded by marketing variable annuities that put customers’ money into “managed volatility” funds. These vehicles, which aim to produce steadier returns, shed risky assets when volatility spikes.
Providers of the biggest such funds include the MetLife spin-off company Brighthouse, AIG’s SunAmerica and Columbia Threadneedle, part of Ameriprise, according to the variable annuity specialists Soleares Research. Bridgewater, the world’s biggest hedge fund, estimates that there is about $350bn invested in “managed volatility” accounts.
Aaron Sarfatti, partner at Oliver Wyman, estimated managed volatility funds — also known as “target vol” funds — sold $80bn to $100bn of stock futures in recent days.
“It’s a substantial share of the selling volumes,” he said, adding that the funds’ remit meant they responded quickly to market gyrations. “It’s very common for them to sell within a day of the emergence of elevated volatility.”
Variable annuity assets invested in such funds rose from about $55bn in 2011 to $275bn as of the third quarter of 2017, said Soleares.
“Since these funds trade out of equities during downturns they can, ironically, actually increase market volatility because so much money is moving out of equities as a result of the volatility controls,” said Steven McDonnell, Soleares founder. “That’s what people are concerned about.”
Variable annuity providers and their advisers downplayed their contribution to the market downturn, arguing that the funds did not employ leverage and that selling had been spread over several days.
“There’s no denying that these vol control funds have been selling, but I think it’s a very, very small percentage of the total,” said Joe Becker, director of portfolio strategy at the actuarial service provider Milliman. One large manager said: “The funds have been doing exactly what they’re designed to do.”
Variable annuities offer customers the benefits of equity mutual funds — creating the potential for juicy returns — while also offering protection against heavy losses. The guaranteed returns can make them problematic for providers.
Before the crisis, insurers generally put variable account money into traditional investments, which caused heavy losses when prices plunged last decade.
Several companies, including The Hartford, ING and Genworth, wound down or exited the variable annuity businesses. In response, providers steered customers into the managed volatility alternatives.
“It would be unwise to claim that the drop on Monday was caused by target vol but it clearly contributed to exacerbation of the move,” said Maneesh Deshpande, equity derivatives strategist at Barclays.