A new whitepaper has identified derivative-based overlay strategies as the latest growing equity strategy among investors.
The white paper, ‘DNA of a Manager Search: Equity Overlay’, written by bfinance has found that investor appetite for equity overlay strategies had increased through 2018.
The paper found investors were turning to derivative-based overlay strategies to hedge against equity loses and to protect against artificially-stimulated asset prices.
Bfinance said that over the past decade sophisticated investors who took aggressive measures to insulate against losses by running up large cash holdings among other strategies had been largely unrewarded for them.
However, the white paper established 2018 as a turning point with more investors seeking explicit forms of protection with the overlay strategies falling into three categories: static, evolving static and dynamic.
Static is the simplest of the strategies with the protection level decided at the outset and cost driven by the implied volatitily.
Evolving Static adjusts the hedge and establishes a new option position should market dynamics change.
The most complex of the categories was dynamic which involved active trading and protection levels evolving with the market.
Managing director of risk and diversifying strategies at bfinance Toby Goodworth said the trend among investors was clear.
“We have seen a clear trend among investors seeking more explicit forms of protection against equity losses over the past twelve months as artificially-stimulated asset prices have given way to increased market volatility, geopolitical tensions and trade war concerns,” he said.
Mr Goodworth said the prospect of more severe downturns had only strengthened the case for more explicit safeguards.
“Equity overlay strategies are being sought in contrast to the past decade where investors had been building up implicit downside protection through diversifying strategies,” he said.
Investors should be mindful of the change of approach said Mr Goodworth and they needed to consider the level of complexity to utilise.
“When it comes to applying overlays, simplicity is not always straightforward so investors should ensure they are well-equipped to consider the level of customisation required with the desired level of tactical adjustment and the types of instruments to be employed with an awareness of the trade-offs that are involved,” he said.
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