Overlay Management

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 Overlay^PLUS)

• 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

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 Overlay^PLUS)
  • 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

Overlay control logic is fine-tuned to tactical signals

• Can be used irrespective of the signal provider
  • Successful cooperation with Vontobel Asset Management for more than 10 years
  • Tactical signals play a fundamental, active role

• Performance harvesting through signal-dependent limits for risk budgets equity, fixed income and currency (see FX Overlay)
• Anti-cyclical, tactical re-entry into the market through signal-based budget release
• Intelligent risk budget allocation through tactical signals

There are several reasons for going off track with a portfolio. And there is a tried-and-tested way to stay on track. Not only in years with economic, political and social challenges, overlays can be very helpful but also in years that are quieter. The following simulations of 2024, 2022 and 2020 illustrate what this can look like.

The simulations based on the following strategic asset allocation (SAA): 40% global equities, 60% bonds (government bonds) Euroland, USD-EUR hedge, 8% risk budget, hedging via index futures.

^{Source: Universal-Investment-Luxembourg S.A., Frankfurt branch}

• SAA with Risk Overlay^PLUS: very close to SAA-Performance without Risk Overlay^PLUS; no significant impact on the upward and sideways market.
• SAA without Risk Overlay^PLUS: no significant drawdown phases that would have required a hedge therefore similar trend like SAA with Risk Overlay^PLUS.
• Upward and sideways market: Risk Overlay^PLUS remains neutral, so that no distortions occur in the comparison to SAA without Risk Overlay^PLUS.
• Bonds: slightly outperformance based on targeted hedge in spring.
• Equities: no hedge; benchmark performance was achieved 100%

^{Source: Universal-Investment-Luxembourg S.A., Frankfurt branch}

• SAA with Risk Overlay^PLUS: Effective downside protection (holds lower limit); larger drawdowns have been avoided (max. drawdown only half as high); risk budgets have been used up during the year.
• SAA without Risk Overlay^PLUS: Significant decline in the portfolio due to market developments; crosses the lower limit from April, only a short recovery in July. 

^{Source: Universal-Investment-Luxembourg S.A., Frankfurt branch}

• SAA with Risk Overlay^PLUS: Effective protection during the crises, portfolio drawdown of only -6.23% and quick re-entry into the market.
• SAA without Risk Overlay^PLUS: Significant decline in the portfolio due to market developments in March, clearly crosses the lower limit of 92, max. portfolio-drawdown of -13.65%.

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^PLUS – with tactical signals by Vontobel

• Reduction of the hedge ratio when signals show a positive environment.
• Reduction of opportunity costs from currency hedging with very low volatility and significantly reduced drawdowns from currency effects.
• Significant relief on liquidity from currency hedging.
• Integration into Risk Overlay^PLUS equity and fixed income possible.
• Additional protection by carrying a risk budget.
• Improvement of risk-return profile.

The simulation is based on the following assumptions: currency effects in EUR. Calculation of the results by means of hedging with 3-month FX forwards. The currency exposure is 100% USD.

^{Source: Universal-Investment-Luxembourg S.A., Frankfurt branch}

Please note: opportunity costs may be incurred when using an overlay. Past performance is not a benchmark for future performance.

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. Illiquid structures (private equity, real estate, etc.) can be easily integrated into currency management.

Manuel Stratmann Head of Trading, and Glenn Marci, Team Head Overlay Management at Universal Investment describe the characteristics of our three overlay approaches.

Universal Investment’s portfolio management team presents the different aspects of overlay management.