Sounds good… but…
By Bill Boersma
I’ve listened to the chatter about engineered and volatility controlled index funds for quite a while now, mostly courtesy of Bobby Samuelson, and I understand them and what the issues are. But, without getting under the skin on them yourself, it’s hard to appreciate everything. A current case involves an IUL where much of the money is in two popular volatility controlled indexes..
The point of volatility controlled funds is to control volatility; clever. But why do the insurance carriers offering these want to control volatility? Because the cost of options rise when volatility rises and paying more for options reduces cap rates. Thus, lower volatility = lower options costs = higher cap rates. When a meaningful percentage of agents and consumers are drawn to the shiny cap rates, if yours aren’t impressive you lose out. As you’ll see, actual performance doesn’t really matter.
The question posed by the policy owner is why his policy did so poorly when the markets have been on fire? He’s in a couple of $20 million premium financed IULs and everything seemed to be going fine until it didn’t. By the way, these things always are doing great until they’re not. And when they’re not, they’re really, really not, it always seems to turn on a dime and the entire time the agent is saying the policy has been doing better than originally projected. (I mean just about every time it’s the same exact thing.)
So… why?
Here’s a graph of the bonds/equities balance in a popular fund. You can see that equities allocation goes from a high of 100% to a low of 0%. As write this it’s 38% equities exposure, which is the highest of the current calendar year. It was 23% when I checked last month.
This is a bit of an outdated graph for the other one. It’s a hypothetical chart going back to 2005 based on how the two underlying indexes would have looked, had the Index existed before it came into existence in 2015.
Check out the 5 year return
At least the 10 year is positive, but it doesn’t even beat inflation. The one year is just barely positive.
Check out this comparison of the S&P 500 and the average engineered index.[1]
There was an article earlier this year in an industry publication listing the most popular volatility controlled indexes and the best one did 39% of the S&P 500. Ignoring the first one with a growth relative to the S&P 500 of negative 1,100%, the average percentage growth of listed indexes compared to the S&P 500 is a fraction of one percent.
Here’s the S&P 500 on a compounded basis.[2]
Here’s the bottom line; I asked ChatGPT to create a graph comparing the S&P 500 with a volatility controlled version with the VIX held constant at 5, which is not uncommon for an IUL volatility controlled index.[3]
I could rattle off a multitude of other issues, including cap rates, sequencing of returns, the lack of dividends included in the S&P 500 Index, etc. to explain why an IUL will never perform like a security, but the simple fact that volatility controlled indexes aren’t even always or fully invested in securities is pretty darn meaningful. You can only expect returns commensurate with what you own.
Bill Boersma is a CLU, AEP and LIC and the founder and owner of OC Consulting Group. More information can be found at www.OC-LIC.com, www.BillBoersmaOnLifeInsurance.info or email at bill@oc-lic.com or call at 616-456-1000.
Securities offered through Valmark Securities, Inc. Member FINRA, SIPC. Investment Advisory Services offered through Valmark Advisers, Inc. a SEC Registered Investment Advisor.
OC Consulting Group and its affiliates are separate entities from Valmark Securities, Inc. and Valmark Advisers, Inc.
Data shown in graphs and tables are for educational discussion only. They are intended to demonstrate the general impact of volatility controls on index behavior and are not intended to predict or project returns of any specific insurance or investment product.
The information provided has been derived from sources believed to be reliable but is not guaranteed as to accuracy and does not purport to be complete analysis of the material discussed.
[1] Forum 400 presentation
[2] www.DQYDJ.com
[3] ChatGPT prompt “S&P 500 graph with a VIX of 5”
