Staying on Track with Overlay Management
Overlay Management Concepts: individual, modular and proven
Every investor has their own unique investment strategy and their own unique approach to strategic asset allocation (SAA) and their own preferred driving style.
The portfolio management team has competently, professionally and successfully steered overlay mandates on the ideal line for more than 20 years, using a tailored overlay approach proven in diverse market environments. Overlay concepts are available specifically as FX Overlay, as well as in modular form as Risk Overlay and Risk OverlayPLUS.
Overlay mandates under management (on your platform of choice as well as outsourced overlay management as an administrative KVG) total 39 billion euros. In order to stabilise portfolio performance, Universal Investment provides a comprehensive management of equity-, interest-rate-, currency- and spread-related (optional) risks, using derivatives in a separate overlay sub-segment. As a Master KVG, Universal Investment has an overview of the fund, including, for example, its FX exposure (as of April 2022).
Overlay Management Approaches
Risk Overlay: System
Each overlay mandate is tailored to the investor's specific requirements
- The opportunity to participate in positive market developments, as well as to mitigate the effects of negative developments (defending the lower limit)
- The chance to react quickly and flexibly to market risks
- Risk monitoring of individual securities – including outsourced overlay management through an external asset manager (KVG)
- Modularity: separate budgets for different risk types
- The main risk categories: equity-, interest-rate- and currency-related risks
- Non- or only partly-manageable risks, including, for example, spread and overnight risks
- Dynamic risk budgeting by means of tactical signals (Risk OverlayPLUS)
- Assessment of different asset classes, risk categories and overlay specifications
- Hedge quality, risk allocation, risk budgeting
- Regulatory and governmental guidelines
- Management of risk categories either individually or as a whole
- The tailored overlay is underpinned by a customised software solution
Risk Overlay: Effectiveness
A modular overlay approach – hedging only where necessary
- Allows a customised approach through modular concepts
- Consistent risk overlay process tailored to various risk categories
- Targeted use of derivatives: derivatives hedge risk categories rather than asset classes
- Reduces the tendency of a pro-cyclical reaction by making anti-cyclical risk budget transfers between individual budgets (Risk OverlayPLUS)
- Diversifies where appropriate and hedges risks where necessary
- Reduces the likelihood of an expensive full hedge
- Increases risk transparency, for example through performance by risk category
Risk OverlayPLUS: Tactical Signals
Overlay control logic is fine-tuned to tactical signals
- Can be used irrespective of the signal provider
- Successful cooperation with Vescore by Vontobel Asset Management for more than 10 years
- Tactical signals play a fundamental, active role
- Performance harvesting through signal-dependent limits for risk budgets
- Anti-cyclical, tactical re-entry into the market through signal-based budget release
- Intelligent risk budget allocation through tactical signals
Tactical Signals – Simulations
Risk OverlayPLUS – Tactical signals Vescore by Vontobel
There are several reasons for going off track with a portfolio. And there is a tried-and-tested way to stay on track. The following simulations of 2020 and 2021 based on Strategic Asset Allocation (SAA) illustrates what this can look like: 40% global equities, 60% bonds (government bonds) Euroland, USD-EUR hedge, 8% risk budget, hedging via index futures.
- SAA with Risk OverlayPLUS: optimal hedging of downside risk and timely reentry into the market
- Bonds: minor difference in performance due to hedging in summer
- Equities: benchmark performance was achieved 100%
- Upward and sideways market: no effect on SAA with Risk OverlayPLUS
- SAA clearly crosses the lower limit of 92% in March 2020
- Risk OverlayPLUS holds the lower limit: Outperformance through hedging and timely reentry
Please note: opportunity costs may be incurred when using an overlay. There is no guarantee that the lower limit will always be maintained. Past performance is not a benchmark for future performance.
FX Overlay: Currency Hedging
The main goal of an FX overlay is to mitigate the currency risks associated with investments in global equity, bonds and illiquid Assets, like Alternative Investments or Real Estate. Based on this, Universal Investment offers rule-based currency hedging, either directly in the respective fund or centrally
in a separate overlay sub-portfolio. The sub-portfolio can potentially include a reduction in cash requirements and considerably lower costs as a result of competitive trading according to a best-execution approach. To complete the overall FX Overlay process, collateral pool management is also available.
A choice of FX overlay structures is available:
FX Overlay – with FX Futures / FX Forwards
- Static hedging of fixed hedge ratio
- Netting effects used at master fund level in centralised overlays
- Effective mitigation of currency risks
- Clear and transparent processes
FX Overlay – with a combination of FX forwards and FX options
- Innovative mechanism: hedging of currency risks using a combination of forwards and options, potentially reducing cost of carry
- Zero-cost-collar structures possible, eliminating initial premium costs for options
- SAA and FX exposure adjustments done via forwards, adjustments to the optional structures usually not required
In addition, the administrative Master KVG vehicle provides a holistic overview of the entire currency exposure in a master fund.
Manuel Stratmann and Glenn Marci, Senior Portfolio Managers Overlay & Quant Models at Universal Investment-Luxembourg S.A., Frankfurt branch describe the characteristics of our three overlay approaches.
Overlay approaches come in several forms
Universal Investment’s portfolio management team presents the different aspects of overlay management.
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