Overlay management has evolved. It’s no longer about the selective hedging of individual risks but about finding the most effective management for the available risk budgets.Peter Flöck
Black swan events come and go. Unprecedented negative events in the market unfortunately often take their toll on investors’ portfolios. Agreed lower limits come under pressure, the opportunity to re-enter the market when it recovers is missed or an overall adjustment of the strategic asset allocation (SAA) is required. In this regard, every unforeseeable event also has a positive side: investors gain new insights that can be drawn on when they assemble their portfolios. Crises like the one unleashed by the Covid-19 pandemic have brought services such as overlays and transition management into focus. Services that, whatever the market conditions, investors can hardly afford to do without.
Peter Flöck, Head of Product Management (Portfolio Management) at Universal-Investment-Luxembourg, explains how the Universal-Investment team supports its clients: “Overlay management has evolved. It’s no longer about the selective hedging of individual risks but about finding the most effective management for the available risk budgets.”
Intelligent overlays can help secure lower limits and at the same time reduce opportunity costs. Fundamental to this is an overall risk budget calculation that is based on risk modules that combine similar risks. As this calculation analyses the whole portfolio systematically, it facilitates sponsoring of risk budgets. Budgets for individual risk classes that are not being used at a certain point can be utilised to reduce hedging in other classes. This mitigates the risk of full hedging. The strategy is complemented by an optional tactical allocation control that is able to integrate various signals via open interfaces. The interaction of sponsoring and tactical elements has an anti-cyclical aspect – which is vital to ensure the overlays make a strong contribution to earnings.
Projects with specialist partners are one example of how these strategies are constantly fine-tuned. Universal-Investment has been working successfully with Vescore by Vontobel Asset Management for more than a decade, complementing its own expertise in risk budgeting with Vescore by Vontobel’s specialist allocation signals. The first half of 2020 was marked by a joint project that successfully developed a strategy to fine tune existing risk management models. Universal-Investment is convinced that if risk budgets are tight, it is crucial to not only consider asset allocation but also the allocation of risk budgets for individual risk factors in the SAA. Significant progress was made in the even tighter integration of the tactical market assessment provided by Vescore’s signals, the risk budget allocation and the re-entry system. The the Vescore signals have moreover been limited to purely fundamental statements.
Overlay management has evolved. It’s no longer about the selective hedging of individual risks but about finding the most effective management for the available risk budgets.Victor Bemmann
Crisis periods accompanied by strong market turbulence are an acid test for overlay systems. Spring 2020 and the fluctuations triggered by the pandemic serve as a recent example. Even in this phase, investors could trust Universal-Investment’s intelligent overlay approach. “Our overlays fared well in the immediate stress phases of the crisis. Our approach stood the test both in exits and market re-entry,” concludes Victor Bemmann, Head of Area Portfolio Management at Universal-Investment-Luxembourg. Re-entering a rising market promptly is instrumental in keeping opportunity costs to the minimum long term.
An intelligent Risk Overlay or Risk OverlayPLUS with modular risk budgeting including sponsoring: tactical signals can be used to reduce opportunity costs with Risk-OverlayPlus strategies in particular. This contrasts with conventional value hedging (based on Value-at-Risk [VaR] as a summary risk measure for the portfolio as a whole), which can be costly and often impacts performance. Overall, cutting-edge intelligent overlay management can make a positive contribution to the performance of the portfolio - both in the long term and in acute crises.
Intelligent Overlay Management – equity Portfolio Test 2020
Intelligent Overlay Management – Balanced Portfolio Test 2020
Crucial to the success of any restructuring is that investors involve transition management experts early on.Thomas Casper
Crises are also good indicators of whether the strategic allocation of portfolios needs to be adjusted. In this case, restructuring is often accompanied by significant costs and risks. Professional transition management can help reduce these risks. Case studies back this up. One example is a case of a 500-million-euro US corporate bond portfolio that needed to be transferred to a US equities portfolio with a parallel switch of asset manager. A classical restructuring without transition management would have resulted in a tracking error of 14.06 per cent p.a. or 3.7 million euros over the transition period, even if Asset Manager A had simultaneously sold the bonds and Asset Manager B had built up the equities. Universal-Investment's expert transition management team reduced these risks significantly. The result was a tracking error of only 2.79 per cent.
“Crucial to the success of any restructuring,” says Thomas Casper, Head of Portfolio Management Services at Universal-Investment-Luxembourg, “is that investors involve transition management experts early on." In this case, pre-trade analyses can identify risks, suitable strategies can be developed to reduce risks and costs as well as the necessary service partners brought onboard. But what is meant exactly by "early on" and what sort of timescale can investors expect? A behind-the-scenes report "Chronicle of a Restructuring” provides the answers.
universal spotlight accompanied a typical portfolio restructuring.
March 2019 Telephone appointment with the transition management experts at Universal-Investment. The investor details plans for a major change to the strategic asset allocation and gives a broad outline of the initial- and target allocation. The investor asks the transition management team to carry out an analysis of the main risk drivers and key factors. The team is also asked to draw up a rough timetable for the required implementation.
April 2019 The transition management team presents the implementation strategy with analyses and timetable. Clarification of the following: (1) the handling of cash inflows during the transition period, (2) the timetable for establishing new segments and integrating the new asset managers, (3) the unlocking of possible cross-potentials,(4) the clarification of physical implementation parameters, (5) the link-up with the overlay manager for the required risk management of the portfolio as well as (6) issues surrounding the project completion and transfer to the new asset managers. The implementation strategy recommends that physical assets are divided up into three sub-projects (primarily into the regions Asia, America and Europe) in order to fully unlock cross-potentials. Due to the complexity of the restructuring, third-party transition managers are to be approached and commissioned for the best possible partial implementation.
May 2019 The investor follows Universal-Investment’s recommendation to employ three third-party transition managers to provide a reliable estimate of the full implementation costs. Universal-Investment's transition management team calls for tenders and monitors the process throughout.
June 2019 Universal-Investment experts examine the pre-trade analyses by the transition managers commissioned and prepare a consolidated pre-trade analysis for the investor. As the entire restructuring is to be staggered timewise, the three planned sub-projects are put out to tender again individually by Universal-Investment before the start of the project.
July 2019 The final decision is made on the implementation approach. The investor asks Universal-Investment to execute the three projects with an interval of one to one-and-a-half months, beginning August 2019, and to set up the required technical and contractual aspects.
August 2019 The planned restructuring is implemented. Costs and risks are in line with forecasts.
(Published February 2021)
Author: Victor Bemmann, Universal-Investment
Date of issue: 10/5/2021
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