Introduction to Equity Risk Management and Futures Strategies

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Published on September 18, 2023

| 3 min read

John Cardinali, CFA, Senior Managing Director, Business Development

Navigating the financial markets is like sailing on a vast, unpredictable ocean. The waves represent the ever-changing market dynamics, and the wind propelling us forward is the alpha we strive to capture. However, the increasing frequency of regime changes, driven by macroeconomic forces, has made the journey more challenging. Public equities, while a staple in many investment portfolios, can sometimes leave us exposed to these macroeconomic factors. This exposure can be a boon in favorable conditions, but it can also overshadow excess returns when the tides turn.

Some might be tempted to adjust their equity allocations tactically, essentially trying to time their market participation. However, this approach is like changing your ship’s course with every wave. It’s not only exhausting but also ineffective in the long run. Instead, Intech proposes a different approach: using futures as a tool to offset risks and enhance returns.

Futures are financial contracts obligating the buyer to purchase an asset or the seller to sell an asset at a predetermined future date and price. They can be deployed in two ways: through integration with an active equity portfolio or as an overlay strategy. Both approaches have their unique benefits and considerations, and choosing between them requires a deep understanding of your portfolio’s characteristics and your organization’s capabilities.

Integrated futures strategies involve seamlessly incorporating futures contracts into your equity strategy. This approach allows for swift adjustments to market exposure, insulates your portfolio from downside risks, and potentially amplifies returns. However, it requires specialized expertise and careful management to effectively target equity-specific risks and optimize capital efficiency.

On the other hand, overlay strategies apply futures contracts to the entire equity mandate, providing a broader risk management framework. While this approach offers comprehensive risk management and efficient portfolio rebalancing, it also introduces an additional layer of complexity. Managing overlay strategies effectively requires continuous monitoring and adjustments to align with evolving market conditions and investment objectives.

The Power of Futures in Managing Equity Risk and Adding Alpha

The increasing frequency of regime changes, driven by macroeconomic forces, has led to time-varying volatility, varying lengths of drawdowns and recoveries, and shifting cross-asset class correlations. This new market order has made the management of equity risk more complex and challenging.

Futures offer a powerful tool to navigate these complexities. They provide a mechanism to hedge against adverse market movements, thereby reducing portfolio volatility. This hedging capability is particularly beneficial during periods of heightened market stress, where futures can provide a buffer against significant drawdowns.

Moreover, futures can also serve as a source of alpha. By taking strategic long or short positions based on econometric forecasts and rebalancing adaptively, futures can generate additional returns, enhancing the overall performance of the portfolio. This ability to add alpha is especially valuable in today’s market dynamics, where traditional sources of alpha are increasingly hard to find.

In our upcoming posts, we will delve deeper into the intricacies of both integrated futures strategies and overlay strategies. We will explore their benefits and considerations in detail, providing a comprehensive analysis to guide investors in today’s new market order. Stay tuned for these insightful discussions, and let’s navigate the seas of equity risk together.