Overlay strategies

July 2021

Overlay strategies represent another tool in the toolkit for institutional investors that may allow them to more efficiently meet their objectives. In broad terms, overlay strategies are carried out separately from the underlying portfolio assets and are constructed to target asset allocation exposures or risk characteristics, or to express tactical views. Whereas most investment managers are measured against their alpha generation, overlay managers are primarily measured against their ability to mitigate risks and efficiently execute their mandate.

Overlay managers (“OM”) are engaged to provide a variety of derivatives-based investment strategies. Overlays are implemented through purchasing futures or other derivative instruments so that the net characteristics of the underlying assets and the overlays deliver the desired level of risk mitigation and optimization. When an overlay is added to an investment portfolio, the overlay may effectively represent the addition of economic leverage and, in most cases, the total notional portfolio market value will be larger than the underlying portfolio.

Over the past decade there has been a proliferation of overlay products, and overlay managers are increasingly adept at crafting custom overlay strategies to meet client needs. Our research note offers a brief overview of some of the most common overlay strategies, their benefits, and considerations.