Q:  What is the history and mission of the fund and the company? A : We’re part of an actuarial consulting firm that started in 1947. Its primary business has been in actuarial consulting for four primary areas: life insurance, property and casualty insurance, and healthcare and employee benefits. The practice I’m in is called Milliman Financial Risk Management LLC. We started in 1998 by helping insurance companies hedge the financial risk that was inherent in the products they were selling, which were essentially long-term put options. At that time insurers didn't have a sense of how to hedge those products and the actual financial risks that were inherent in those products. Those insurers that weren’t hedging in the bear market from 2000 – 2003 woke up and started realizing that their product offerings have significant financial risk, because the guarantee pays out if the market drops below the guaranteed level you’ve promised your investors. The insurance company and assets are in mutual funds that have risks to stock and bond markets, however those funds are invested. So we implemented that business and actually took on a lot of outsourcing work from those insurance companies where they basically handed over the keys to their hedging program. We would trade on behalf of the insurance company to hedge the inherent risk in their balance sheet due to those products. We developed a trading floor and we’re a registered investment advisor with the SEC; we’re registered as a CTA with the CFTC, and we’ve also got similar registrations in London for the UK, and in Sydney for Australia. Those are our three trading centers where we operate our risk management strategies. In 2009, we really felt a need for and a demand for us to start to move those hedging processes inside of the funds that are typically offered in variable annuity products. The reason is that it is a win-win for both the policyholder and insurer. In the case of the policyholder, they get a fund that enables them to be more liquid, and that gives them the comfort of potentially not having as much volatility or downside risk, however it still allows them to participate in the markets and to invest in guaranteed type products. For the insurance company, it represents a cheaper product to offer because not as much risk management needs to operate on their balance sheet. More of a risk management procedure is implemented inside the fund and they can charge less or offer more diverse products, in terms of the features of the guarantee. Our first fund that implemented the strategy went live in 2011. We call it the Milliman Managed Risk Strategy™, and since then we've experienced the results that we expected. It has mitigated volatility, and it has mitigated drawdowns in a particular portfolio. However, it has done a good job of allowing upside and market participation through what’s been a long bull cycle since our first funds launched. That gives you an overview of how we got to the point of being in the fund business and being a registered investment advisor for funds. We’re typically a sub-advisor to a given portfolio, so there is an underlying long manager that’s picking the underlying holdings. Then we’re implementing an overlay on those holdings, given how they’re mapped to different index exposures that we can use futures to hedge with. We’re active in the futures markets, and we trade in futures all over the world. Futures are basically an efficient way to short exposure given that you have that exposure in your portfolio and you want to hedge it. They’re efficient hedge instruments that have a lot of liquidity and allow us to operate these strategies to take risk off the table when our processes start to perceive greater risks of a given fund. That’s a high-level overview of where we came from and a little bit on the strategy. Q:  What are the total assets under management across all Even Keel funds? A : In the Even Keel funds we’ve about $305 million. This is just the Even Keel funds. We have several other funds that have larger assets that are not in the Even Keel brand. Our oldest fund was launched in October 2012 and then the four other Even Keel funds, which are single asset class funds, were launched in November of last year. Q:  Are the other funds under a different brand name? A : Yes, they are different brand names because they’re with different insurance companies, some of them are different pensions, some of them are different types of products so they’re not all Even Keel brands but they all implement the Milliman Managed Risk Strategy™. The total assets under management implementing the Milliman Managed Risk Strategy™ is closer to $60 billion and we’re sub-advisor for some, consultant for others. Q:  What is the philosophy behind this fund and who can benefit from it? A : Let me just give you a clarification. Even Keel is the brand for a family of retail funds. For all the other funds and pensions, 401(k)s and insurance products there is a different brand based on the primary manager of the fund. The Even Keel funds are where we are the primary advisor to the fund and we’re the sub-advisor or a consultant to the primary advisor for all other funds. Our practice is Milliman Financial Risk Management and Even Keel is the brand for the retail funds where we are the primary adviser. The Even Keel funds are meant for retirement oriented investors who want to participate in growth but also want to have a stable fund value; one that doesn’t have as much risk as a traditional growth fund and doesn’t experience the type of drawdowns we saw in the financial crisis in 2008 and in the bear markets in 2001 and 2002. It is meant to try to reduce the risk of holding growth oriented investments. Instead of increasing an allocation of fixed income as a risk management strategy, we actually implement a dynamic risk management strategy for the Even Keel funds to try to limit the risks of the investments. We have what we call the Milliman Managed Risk Strategy™ which consists of two basic fundamental components. The first component is volatility management which is trying to keep the portfolio at a level of target volatility. We have a target volatility for each portfolio. When we see volatility start to move above our target, we will short futures to bring it back to that target level. If it runs below the target, then we take those futures off to let the assets grow to get volatility back to its stable level. We don’t lever the portfolios per se, so we don't increase the equity exposure above 100 percent effective equity. For the Even Keel multi-asset portfolio that wouldn’t be above 70 percent effective equity. We’re not in the business of creating leverage to try to create alpha in low volatility markets. However, we do use instruments to manage volatility to a target level so that the ride is smoother along the way. So even this year we’ve seen some pockets of increased volatility and as volatility started to pick up we put some hedges on in the portfolio. As was the case this year, we’ve seen that volatility snap back quite quickly. However, if things did continue to draw down we were very well positioned at each point when we started to see increased risk in the system. A simple calculation could be if our volatility target is 12 percent and we’re seeing volatility of 24 percent, and we take 12 divided by 24, the result should be our weight to equities and the rest of the weight you should have to hedges. You want to hedge to 50 percent of your equity exposure. So that’s in summary volatility management – trying targeted level of volatility because volatility is not a constant factor in markets, it moves around and it can expose your portfolio to risk if it starts to expand. The second component that we implement in the Milliman Managed Risk Strategy™ is what we call the capital protection strategy. The goal of that is to implement on top of the volatility management strategy a process for increasing the hedged position, as we start to see drawdowns in the market. If we do see recoveries from those drawdowns, then we dial that hedge position back. It’s a dynamic approach to increase or decrease the hedge position, given how far we’ve fallen from a recent high water mark or how long we’ve been in a recovery period to start to reduce the hedging so we can participate more fully in the recovery. It’s a dynamic process that comes from our pedigree of the last two decades of doing risk management on insurance company balance sheets for these long-term put options. It comes from the same types of approaches as to try to reduce the left tail distribution more than the right tail, or to try to reduce your maximum drawdown by more than you reduce your maximum participation in strong bull markets. It’s trying to be asymmetric in the way that it reduces risk. That’s the second risk management component. What we found is that doing one or the other on its own has some weaknesses in certain markets. Volatility management has weaknesses in cases where volatility is low but we’re still experiencing drawdowns. The capital protection strategy has weaknesses in that, if volatility is very low, it’s still a drag on the portfolio. Volatility being very low the first component can actually override the second component to give more equity exposure. So when you combine the two together, you get a process that is much more reliable, that doesn't necessarily rely on a single model or a single trigger to execute. Both components work off one another to create a strategy. The fundamental concepts are to stabilize volatility and limit volatility and then to reduce drawdowns by more than we reduce total participation. We’re under the mindset that implementing these types of risk management approaches has a cost and we know we’re not going to perform the same as the market does because we’re implementing hedging. We believe there’s no free lunch and that you do have to pay to implement a hedging program; however, we believe that the benefits associated with implementing this hedge program in terms of reduction in drawdown and the reduction in maximum volatility offset the cost that occurs in some markets where you are not participating 100 percent with what you would otherwise. Q:  Do you match your holdings to mirror risk that you are trying to manage? A : That’s right and we dial that hedge position up and down. One other very critical aspect of this is that it is a very systematic approach. You can boil it down into a set of equations for how much risk we’ll hedge on a daily basis and there’s not any judgment involved. I’m not going to the trading floor and telling them to hedge more or less based on my view. It is really our processes that are calibrated every day to the new market information and that then give us a sense of how much to hedge on a given day depending on much risk is in the portfolio. Yes, it’s a core holding of global exposure or US exposure or in the case of the Even Keel Funds – not the Even Keel portfolio –but the four Even Keel Funds, which are just basically single asset class or single equity sector based. One is U.S. large cap, another is U.S. mid and small cap, the next one is international developed and the final one is emerging markets. For each one of those funds we’re running the processes. The core holdings would be an ETF right now since fund sizes are small but eventually we will get to securities that represent the beta exposure that you want to hit in each one of those portfolios. It’s a passive exposure that we have in those portfolios. Those are the core holdings and then we use futures contracts which line up well with the beta exposures of the portfolio to dial up and down a hedge position and manage the risk. Q:  What drives your macro analytical view, your individual selection view and your asset allocation view? A : Our expertise is really in risk management so we are not out to outperform other portfolios by our security selection, for example, or sector selection. Even for the multi asset portfolio we’re not trying to really deviate that much from market cap weighted global allocation. We are not trying to overweight or underweight a certain macroeconomic play because we have some view. We don’t employ economists to try to forecast what economy is going to do well over the next x number of years; we’re not really in the business of that. The Even Keel funds are really very passive exposures and that's why we have five of them. Four of them being single equity asset classes and then the fifth one being a multi asset portfolio that’s really globally diversified, but not necessarily trying to chase certain returns of a given economy. It’s pretty constrained in the amount of assets that we can allocate to US, to international, etc. It does have a bit of a US bias but that’s really just because we’re in the US and we’re selling it to US investors, not because we have a particular view on a particular economy. In terms of research, we really don't engage in trying to be stock pickers or global economy pickers. We’re really in the business of implementing risk management given a portfolio of assets and that is the case with some of our other funds. We have funds that we are sub-advisors to, for example for the Capital Group that runs the American funds products. So we have several American funds that implement the Milliman Managed Risk Strategy™ and they do the research and they are the ones picking the securities for those portfolios and, given what securities they have in those portfolios, we implement the right basket of futures contracts to appropriately implement the Milliman Managed Risk Strategy™ on those portfolios. We don’t have a big research team of our people picking stocks. We do our research in better ways to run the strategy, better ways to forecast volatility, because that’s a key component of the volatility management processes. You’ve got to come up with a short-term forecast to be able to re-weight your portfolio to try to target that volatility. We try to work on the best way to measure and forecast volatility in a given portfolio and then work on ways to implement our capital protection strategy in a more efficient manner. We want to make sure that that we can implement these strategies without having to trade a lot during the day because they are long-term strategies and we try to limit transaction costs or balance transaction costs with the effects that we want our strategies to have. We employ a lot of quantitative, technical people, several PhDs who look at different aspects of these types of markets. We employ several other researchers who look at how we can implement our strategy on different portfolios, and then how we can improve the process for creating the dynamics that we want to create, which is limited, stable volatility with limited drawdowns. Q:  Can you describe some market events and your approach to risk management? A : I think this year has been a little bit of an anomaly given that we’ve seen a few drawdowns happen after periods of very low volatility that quickly snapped back. But those drawdowns, as we saw volatility start to increase, we increased the hedge position. The hedge position peaked at about 45 percent for a lot of our portfolios when in this latest period in October we started to see drawdowns and the market started to accelerate them. The market quickly recovered and the hedges were moved subsequently to try and help the portfolios get enough participation to move forward given calm markets. That’s how quickly the portfolios can change and in a matter of a couple weeks we had established a 45 percent hedge position for a lot of our portfolios. But if the drawdown had not been 10 percent but had been 30 percent then you would have seen that instead of getting a 30 percent decline in your portfolio it would have been closer to 15 percent, maybe less. One of the more dynamic examples wasn’t with Even Keel funds because they weren’t live. But we had portfolios that were live during the US downgrade in August 2011, and there we saw that market volatility tripled. We had drawdowns much more than the close to 10 percent drawdown that we saw recently and the portfolios reacted well. Again, hedge position increased to between 40 and 50 percent and that’s 40 or 50 percent of account value or assets under management, so that’s hedging a significant portion of the equity out if it’s a 70-30 fund. We’re hedging essentially 20 percent of that portfolio out – and we consider fixed income as part of the hedge position – so dialing up the hedge position to reduce losses in those environments has, especially in August 2011, proved beneficial. We limited the volatility; it stayed close to the volatility targets, of which our most aggressive volatility target was 12 percent. We saw pretty close to 12 percent volatility in our portfolios where the U.S. equity markets were in the 30s and even higher in some cases for volatility in that period. Since then there’s really been a pretty monotonic bull market, with a few pockets here that we’ve seen lately and we’ve seen these portfolios have participated in a lot of that growth since the drawdowns in 2011. Q:  What are the events that you look for or are important to you that require risk management? A : Because we don’t implement a view or we don’t have someone saying this event could be very catastrophic to the portfolios let’s start to defend against it, and because we’re not trading in something else other than futures that are correlated with the portfolio, let’s say you’re preparing for a hurricane and the hurricane is pretty far off, you could buy hurricane insurance. We could say there may be a “financial hurricane” in the future and buy hurricane insurance, in this case it would be put options for the portfolio, but the problem with that is that if you do that every time you think there's going to be a hurricane in the distant future, you are going to pay a lot of money purchasing those options just for that one event. The way we do it is we try to recalibrate, or recalculate our approach each day and, as we start to see events unfold and as volatility starts to pick up, that's when the portfolio limits start to reduce the exposure to markets. So it’s a dynamic approach, it’s almost like having contractors on call and if the hurricane is currently hitting a couple hundred miles away, the contractors are going to come and board up your house. It’s more dynamic than saying there’s a hurricane that may happen in a month’s time, let’s start to prepare even though we can’t see it yet. We have to see it unfold otherwise we’re going to erode our participation in upside because we have to keep purchasing these puts to try to defend against downside. Just to be clear, we’re not purchasing puts anywhere in our approaches, it’s a fully futures-based approach, but we don’t have a specific event in mind that would cause markets to be more risky than others. When we start to see volatility, when we start to see drawdowns, we act to limit further drawdowns and further volatility and then, when we see those come back, that’s when we start to take the hedge off, to participate in a potential recovery. It’s effective at limiting volatility and reducing downside and trying to keep them set up for growth, but not doing it in a way that’s a black box approach where we’re trading in 26 different futures contracts, including ones are really not related to the portfolio. Q:  So it’s a day-to-day approach, if we put this in a framework? A : Yes, if we had a portfolio heavy with companies that were issuing mortgages and that portfolio started to experience volatility, then we would start to hedge. In our testing in the financial crisis you really start to get very significant hedge positions by the end of September, after the Lehman fails and the next two months are very well insulated. It’s all hypothetical but if we would have traded back then it would have been more than a 50 percent hedge position by the end of the crisis period. It’s dynamic, it’s reactive, but built on a sound theoretical framework and we measure what we know we can measure. We’re not taking bets that in different environments the markets are going to go one way or another. We’re really just trying to react as we see information coming in. Q:  Do you have a benchmark and are there any diversification steps that you follow? A : Benchmarking I think for these types of products has been difficult, because there is really not an index we can point to in implementing our strategy. For the Even Keel funds, which are very basic, index exposure plus the risk management strategy, you can think of that really as the index. But in terms of actual benchmarks, the typical way we will do it is we will try to figure out what blend of equity and fixed income matches the risk characteristics of the portfolio. That’s really what we think of as an alternate. You can take one of the managed risk funds or you can increase your fixed income exposure. So what we may do is benchmark – the Even Keel Managed Risk Fund, I don’t have the exact benchmark in front of me – but we can benchmark the Even Keel Managed Risk Fund, which is 100 percent equity with the managed risk strategy to something like 70 percent S&P and 30 percent Barclays Aggregate benchmark. That would do a better job of matching the risk exposure in terms of volatility that you expect from both portfolios. Again what we expect our portfolio to do to is outperform the 70-30 strategy by allowing you more equity exposure on average with the same risk profile in terms of volatility. Q:  Could you clarify the holdings, are they individual securities or ETFs? A : These aren’t meant to be specifically ETF portfolios; it is just more efficient right now because the fund size is small. For the four Even Keel single asset, single equity sector funds they are holding ETFs and then using futures. For the Even Keel multi asset portfolio, that’s a fund of funds concept where we have a multi manager approach. We have a process for due diligence on those managers as well as tracking them in terms of their performance against benchmarks we design for them. If they get outside of those benchmarks too long then we’ll replace the fund and we’ll also replace the fund for other issues like a very prominent fund manager leaving, like just what happened with PIMCO. But, we’re not trying to produce alpha even in the multi asset portfolio with our selection of the underlying funds and just sticking to a global diversified portfolio with a bit of a US bias, which is what we thought the demand was for. In the Even Keel funds we don’t plan to implement holding individual securities until the funds are much larger and that becomes much more efficient. But they’ll still stick to their mandates in the prospectus. Even Keel Managed Risk is the U.S. large cap focused, so we’d be trading U.S. large cap companies to get performance similar to the S&P 500 index. For the Even Keel Opportunities Fund, that’s meant to be 70 percent mid-cap, 30 percent small cap so it tracks about 70 percent times the S&P 400 index and then 30 percent times the Russell 2000, that’s what the underlying holdings would be. For Even Keel Traveler Managed Risk, right now it’s holding the Vanguard International Developed Ex North America ETF, so again that’s the exposure it’s meant to replicate. If we traded individual securities it would be the securities that are in that index or represent that index. In the prospectus you'll see that it denoted that international developed companies is what we would hold if we were holding individual securities. For Explorer it’s the same thing but for emerging markets. So we are not holding individual securities yet, but if we do get to a point where we’re big enough, and where that becomes efficient, we will do that but again and stick close to our beta exposure of a given equity sector. Q:  How do you define risk, how do you measure it and how do you manage it? A : We define risk in more of a distributional sense. You have risk of drawdowns, which is greater the more volatile the underlying holdings are, and then risk is really three components: the maximum volatility at any given point time, it may be the maximum volatility you’ve experienced over a 21 trading-day rolling window for example; maximum drawdown and then total volatility over any given point in time, so volatility over a month, a week, a year for example. You’ll notice that return is not really one of those risk factors, we’re not trying to forecast returns, we’re not trying to use returns as the basis for our risk management process, we just look at distributional effects on the portfolio – maximum volatility, maximum drawdown and total volatility. We manage those and we measure them by implementing models that measure very short term volatility of a given portfolio and given that measurement that’s how we react to limit volatility and drawdowns. We’ve done a lot of research on that measurement process, that is the one we’ll always be doing research on – how do you measure volatility over the next few days of a given asset class. The more accurately we are able to do that the better results we’re going to have given our strategy. How we manage it is basically when we see that the volatility we’re measuring is above our target we will reduce exposure and if we see volatility at or below our target we’ll reduce our hedge position to its minimal setting, which means the portfolios get most of the participation in the market. Q:  To use a crude analogy, are you in the business of selling shock absorbers so that the ride is smooth? A : Exactly. It’s a shock absorber. It’s not meant to cut off every drop, it’s meant to soften the blow. It’s a good analogy. Q:  What goes into setting your volatility targets and is it based on historical perspective or other factors? A : It’s mostly from a historical perspective. Our targets are usually the volatility that we see as equilibrium volatility in a given asset class, so the US volatility target would be close to something in a range of 16 to 18 percent because the S&P 500 has 16 to 18 percent realized volatility over the long haul. That’s how we set it and that’s usually optimal. You can’t really tell if anything is always going to be optimal but that’s usually pretty close to the best way to run a strategy. Q:  Are there any asset classes that you have other than equities and fixed-income? A : There are funds that we have where we’re sub-advisor or consultant that have other asset classes like commodities or REITs or even some private equity investments and the like and they are typically excluded or included for volatility purposes and not explicitly hedged because the allocation is small and it’s also very cumbersome. It becomes more cumbersome to implement a hedge on something that doesn't really map well to futures contracts.