The evolution and advantages of custom indices

Custom indices are gaining in popularity as a means of helping clients meet their financial goals. Athene, a leading provider of fixed indexed annuities, is at the forefront of this trend with its innovative custom index solutions.

In this interview, Adam Politzer, senior vice president and chief product officer, speaks to INN about what makes custom indices so effective at providing clients with value and protection from market downside.

INN: Can you set the stage by explaining what custom indices are and how they differ from benchmark indices like the S&P 500^®?

Politzer: When we talk about custom indices, we’re referring to a specialized type of index designed to work within a fixed indexed annuity (FIA). While most people are familiar with benchmark indices like the S&P 500^®, a custom index is tailored to track a specific investment style and typically includes exposure to a range of asset categories such as equities, bonds and commodities. One important distinction of custom indices is they’re entirely rules-based, which means performance is mathematically driven as opposed to people-driven, so generally more accurate in terms of what’s happening in the market.

INN: What inspired Athene’s use of custom indices, and what’s changed in recent years that you see as a benefit to clients?

Politzer: The inspiration for using custom indices in FIAs came from the limitations of traditional point-to-point caps on the S&P 500^®, which offered decreasing growth potential as rates fell. Custom indices were introduced to meet the need for higher growth potential. Since then, there's been an extraordinary amount of innovation.

Unlike the S&P 500^®, custom indices were designed to provide more consistency and predictability, making it possible to offer better rates and an improved experience. Moreover, custom indices allow for greater diversification, exposing clients to a broader range of asset classes. Additionally, our custom indices are built on fundamental principles that aim to maximize growth potential for the amount of risk taken, which differs from the S&P 500^®’s purpose of tracking the 500 largest companies.

These factors combined have led to the creation of better financial products, including the current generation of FIAs.

INN: Some financial professionals may be skeptical of the accumulation potential shown for custom indices. How do you respond to this concern, and what strategies are used to optimize growth while minimizing risk?

Politzer: It can certainly be difficult to keep track of the various components of the many custom indices in the marketplace today as well as understand how those components are valuable to clients, which is why education is so important. Custom indices are primarily designed to provide protection from market downside.

All of the underlying components are familiar benchmarks or investable products with plenty of liquidity. These underlying components have been around for years, and because the indices are fully rules-based, we’re able to show how these indices would have performed prior to them being in existence.

While our custom indices show strong performance when tested retroactively, we believe they are designed to work prospectively as well because they are built on strong academic principles, like diversification, which hundreds of years of data has proven effective.

INN: To anyone who believes custom indices are inherently complex and not as transparent as benchmark indices, what would you say, and what steps have been taken to improve transparency and understanding of these indices?

Politzer: We understand custom indices can be complex, but we firmly believe they create value for clients. To improve transparency and understanding, we’ve worked with The Index Standard^® to focus on 122 years of custom indices research to both explain how they work and would have performed over various market conditions.

As more complex indices enter the market, it’s important to ensure they’re built on sound financial principles and not just designed to perform well in a historical backtest. At Athene, we make sure everything we introduce into an index makes academic sense and is built on solid principles.

The volatility control features on our indices allow for greater stability and predictability of the index’s performance. For example, one of our index’s volatility control is balanced every hour. This results in better pricing and interest credits for clients.

INN: Since protection from market risk is intrinsic to a FIA, what role does volatility control play in a custom index?

Politzer: Firstly, it allows us to offer greater participation rates, often in excess of 100%, without a cap. This is because volatility controlled indices are easier to hedge because they result in a smoother performing index.

Secondly, volatility control helps to ensure more consistency in renewal rates, as we can be more confident in the cost of these options and offer clients consistent participation rates at renewal.
While some financial professionals may initially question the need for volatility control in a principal-protected product, we believe it plays a critical role in optimizing growth potential and reducing risk.

INN: Can you talk to us about the volatility target on a custom index compared to the volatility of the S&P 500^®?

Politzer: When it comes to the total value we provide our clients, we allocate the same option budget regardless of the index strategy. The native volatility of the S&P 500^®, which people may be familiar with, is usually around 20%. If we have a 3% option budget, we may be able to offer 50% exposure to that index on a given day.

However, if we add a volatility control with a target of 5%, which is a quarter of the volatility of the S&P 500^®, we could potentially offer participation rates that are four times as high. This means the total value of the product remains the same, but with the addition of volatility control, we can offer clients greater growth potential with a smoother-performing index.

INN: What would you suggest a financial professional and their client consider when comparing one custom index to another?

Politzer: When comparing custom indices, it’s crucial for financial professionals and their clients to weigh the client’s goals and need for diversification.

Additionally, it’s important to consider that participation rate multiplied by index performance is what determines the index return. So, to make an apples-to-apples comparison, you need to understand the participation rate relative to the index return.

For example, a 10% return with a 50% participation rate would result in a 5% interest credit, while a 5% return with a 200% participation rate would result in a 10% interest credit. Ultimately, it’s not just about the pure index return, but also the strategy performance over time.

INN: What do clients expect from an index and how are Athene’s custom indices designed to meet and exceed these expectations?

Politzer: Athene’s custom indices are designed with diversification in mind to help ensure they perform well in almost every economic environment. Our expertise in curating the best set of index solutions and having a wide selection of indices allows clients to take advantage of the diversification we offer. By spreading money across these index strategies, clients are more likely to have a consistent experience and accumulation within the products.

INN: How do you see custom indices evolving in the years ahead?

Politzer: Athene is a company that strives to stay ahead of the latest innovations, and I can tell you that custom indices are only going to get better in the years ahead. We’ve already seen exciting developments, like more sophisticated versions of volatility control and the use of AI to pick better stock portfolios and macro investment strategies for indices. And I’m confident these trends will continue, leading to even more effective and efficient index solutions for our clients.

But it’s not just about the latest technology; diversification will also remain crucial. By offering a wide range of custom indices that can help provide that diversification, we can help our clients navigate whatever comes their way.

INN: What advice would you offer financial professionals who are considering using custom indices, and what resources would you recommend to help them explain the value to their clients?

Politzer: We recognize the importance of simplifying custom indices and making them easily accessible for financial professionals and their clients. That’s why we’ve invested significant time and resources into quarterly webinars with our partners and creating dedicated webpages, providing a comprehensive library of materials.

These resources range from beginner-level content to more sophisticated information on how custom indices work and improve financial outcomes to point-of-sale collateral. Our content is designed to be easily digestible, providing small, bite-sized chunks of information that can be shared with clients. In addition, we offer simple recommendations on how to build a properly diversified portfolio with our indices.

To learn more about the value of custom indices, visit Athene.com/INN-IndexInsight.