Case Studies: Integrated vs. Overlay Futures Strategies

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Published on October 6, 2023

| 9 min read

John Cardinali, CFA, Senior Managing Director, Business Development

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In our journey through the world of equity risk management and futures strategies, we’ve explored the benefits and considerations of both integrated and overlay approaches. Now, it’s time to bring these concepts to life with illustrative examples.

Let’s examine two hypothetical illustrations: The Metropolis Teachers’ Pension Plan (MTPP) and State University (SU). MTPP is a large pension fund that uses an integrated futures strategy, while SU manages a substantial endowment with an overlay futures strategy. These case studies will shed light on how these different approaches can be applied in practice.

Metropolis Teachers’ Pension Plan: Integrated Approach

MTPP hired an equity manager who integrated futures contracts directly into its equity strategy. This approach allowed MTPP to target equity-specific risks with increased accuracy and adapt swiftly to market fluctuations. MTPP also sought to generate additional alpha through adaptive rebalancing, exploiting correlations between econometric factors and equity exposures. The integrated approach streamlined governance, with a single equity manager responsible for both equity and futures management. This consolidation of roles reduced governance costs and simplified oversight.

State University: Overlay Approach

SU, on the other hand, chose to employ an overlay futures strategy for its total portfolio. This approach provided broader risk management capabilities, mitigating the impact of market downturns on the entire portfolio. SU also sought to generate alpha through strategic positioning in futures contracts, leveraging market forecasts and pricing inefficiencies. However, this approach required continuous monitoring and adjustments to remain effective. It also introduced additional complexity, necessitating specialized expertise.

Integrated Approach Overlay Approach
Plan Profile The Metropolis Teachers’ Pension Plan (MTPP) is a large pension fund that uses an integrated futures strategy to manage equity risk within its portfolio. MTPP hired an equity manager who integrated futures contracts directly into its equity strategy. State University (SU) manages a very large endowment with many asset classes, choosing to employ an overlay futures strategy for its total portfolio. SU has implemented a system to continuously monitor and calibrate the overlay strategy to mitigate risks in the underlying equity portfolio.
Risk Management Systematic beta modulation offers the capacity for more precise control over equity risk exposures, allowing for fine-tuning of risk and the targeting of equity-specific risks. Broad risk management capabilities afforded by the overlay provides potential downside protection and mitigates the impact of market downturns on the entire portfolio.
Alpha Generation Seeking additional alpha through adaptive rebalancing, which attempts to exploit correlations between econometric factors and equity exposures. Seeking alpha through strategic positioning in futures contracts, which attempts to leverage market forecasts and pricing inefficiencies.
Capital Efficiency Enhances capital efficiency by collateralizing the equity portfolio using a modest cash position, allowing for effective risk mitigation and optimization of leverage. The application of futures contracts in overlay strategies may lead to less optimal capital efficiency, as it requires the investor to dedicate a specific portion of the asset allocation to managed futures.
Governance Streamlined governance with a single equity manager responsible for both equity and futures management, reducing governance costs and simplifying oversight. May require more complex governance structures, as one or more futures managers may be required to construct the overlay strategy.
Cost Potential cost advantages since integrated solutions are designed to compete directly with large core equity solutions, requiring managers to set fees competitively. Overlay strategies may offer more limited cost advantages, as they aim to deliver portfolio-wide value and are typically priced in comparison to other managed futures providers.
Key Challenges Potential risk of overexposure to equity risk and the need for specialized expertise to manage the futures component. Overlay strategies require continuous monitoring and adjustments to remain effective and may introduce additional complexity that necessitates specialized expertise.

Lessons Learned

These hypothetical case studies highlight the importance of aligning the chosen strategy with the unique characteristics and objectives of your portfolio and organization. Integrated futures strategies offer a streamlined approach, providing more precise control over equity risk while optimizing capital efficiency and reducing costs. On the other hand, overlay strategies offer broader risk management capabilities but require careful oversight and ongoing monitoring to maintain their effectiveness.

In the end, the choice between integrated and overlay futures strategies is not a one-size-fits-all decision. It’s like choosing the right ship for your voyage. The best choice depends on your destination, the conditions you expect to encounter, and your crew’s capabilities. By understanding the benefits and considerations of each approach, you can make an informed decision that best aligns with your investment objectives and risk management goals.

 


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Past performance cannot predict future results. Investing involves risk, including possible loss of principal, fluctuation in value, and total loss of investment.

Investing in futures is speculative, involves substantial risk, and is not suitable for all investors and is for designated institutional investors who have the resources and financial expertise to understand the risks and limitations of such a strategy.

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Past performance cannot predict future results. Investing involves risk, including possible loss of principal, fluctuation in value, and total loss of investment.

Investing in futures is speculative, involves substantial risk, and is not suitable for all investors and is for designated institutional investors who have the resources and financial expertise to understand the risks and limitations of such a strategy.

The hypothetical illustration does not represent the returns of any particular investment.

This information may be restricted by law, may not be reproduced or referred to without express written permission or used in any jurisdiction or circumstance in which its use would be unlawful. We are not responsible for any unlawful distribution of this material to any third parties, in whole or in part. The contents of this material have not been approved or endorsed by any regulatory agency.