Protected equities: reconciling long-term performance and risk management
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Each month, LBP AM deciphers market news in video. This October, Samuel Colin and Thomas Lacharme, Diversified and Multi-Management Managers, share their views on protected equities in our "Vu(es) sur les marchés" feature.
For investors looking for a strong performance on the long-run, equities remain a must have. But mixing up long-term potential and risk management in the current environment - with equity indices still close to their all-time highs, with rising uncertainties given the return of inflation and the sharp rise in interest rates over the past 2 years, and with geopolitical tensions on the top of that - is not easy doing. At LBP AM, we're convinced that for a risk-management oriented investor who also wish to manage capital charges, a protected equity strategy makes a lot of sense.
Significantly reducing risk through protected equities
Investing on equity markets through protected equities significantly reduces risks, especially in case of a sharp downturn, while capturing a significant portion of the markets' medium- to long-term potential. We have been managing this type of strategy for over 10 years, with a twofold objective.
First, risk reduction by sharply limiting volatility vs. equity investment. Hedging strategies also significantly limit capital requirements. Most importantly, we do our utmost to minimize the downside in the event of an equity shock. Recent examples, in 2020 and to a lesser extent in 2022, have confirmed that this objective has been achieved. Reducing risk is helpful as long as it doesn't cap long-term performance.
Our second objective is to deliver the best possible convexity on the long run, i.e. maximizing equity exposure vs. downside risk, and actively reduce the cost of carrying hedges.
LBP AM hedging strategies
Managed by asset-allocation specialists our strategies mix active management of hedging strategies and SRI equity expertise, with stock selection by our experts at Tocqueville Finance.
Hedging is based on a portfolio of dynamically managed options to adapt the degree of exposure to implied volatility for instance. We pick-up the most accurate options and adjust our portfolio to our market forecasts. This hedging is permanent and actively managed to reduce costs.
We rely on a set of proprietary tools to support our decisions :
- An algorithm for selecting option strategies
- An analysis of portfolio behavior under equity and volatility stress-tests
- Factor analysis to measure how suited the equity portfolio and hedges are.
"The aim is to improve portfolio behavior in phases of strong market downturns"
Our day-to-day management aims to improve portfolio behavior in phases of strong market downturns by limiting the cost of hedging, in exchange for less upside in bullish phases. Over an entire cycle, the aim is to obtain returns close to that of equities with reduced volatility, and a proven capacity to reduce downside in the event of a sharp correction.
We also manage our style allocation, in regards with our market expectations, in order to match investments and hedges. For example, at the end of 2021, we introduced a Value sub-pocket, and its weight has been actively managed since.
This strategy can be tailored to investors' constraints and objectives, such as equity exposure or capital requirements limits.