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Understanding Derivative Overlays, in All Their Forms

February 14, 2013

The proliferation of these overlay strategies has created substantial confusion in terminology, as a multitude of approaches are offered under this term.
-Markus Aakko, executive vice president, PIMCO
-Rene Martel, excutive vice president, PIMCO

 


Derivative overlays have become a mainstay of modern pension fund management. Many plans use overlay strategies in order to achieve a variety of asset allocation objectives, ranging from passive currency hedging to implementation of tactical shifts or even complex hedge fund replication strategies.

The proliferation of these overlay strategies has created substantial confusion in terminology, as a multitude of approaches are offered under this term.

  • Passively managed overlays are typically based on a simple formula, while active approaches involve more complex algorithms or decision-making.
  • Overlay examples include portable alpha, LDI, currency, completion, rebalancing, and tactical asset allocation overlays -- as well as tail-risk hedging and hedge fund replication.
  • Potential benefits include the ability to effectively manage cash, reduce costs and risk exposure, simplify manager transitions and express tactical views.

 

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