25 min read

Tailor Your Risk by Buttoning-up with an Equity Collar

Measuring Tape

Despite the difficulties already experienced through 2022, we expect much of the world to enter a recession in 2023, creating a challenging backdrop for equities. We are most concerned about the most cyclically exposed sectors, but we believe the market will bottom before the recession ends. The path and potential returns from exposure to interest rates are equally uncertain, resulting in a very broad set of scenarios for asset allocation returns.

Fortunately, the market is currently offering favorable pricing on combinations of equity options that can be used to define compelling outcomes for well-funded pension plans. For example, an equity collar today can be structured to potentially provide positive incremental returns for a plan unless the market returns exceed 12% over the next year. In other words, investors who buy a 90% 1-year put option can fully offset the premium by selling a 112% 1-year call option, a structure which cost more than 3% a year ago. This means that, in 2023, a pension plan may be able to eliminate long left-tail equity losses while retaining the first 12% of equity returns without an upfront cost.

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Additional insights

Radar Monitor

Collectively Forecasted, Never Arrived

Investment Outlook | Q1 2024

Like driving on ice, the trick to surviving 2024 may be not over committing in one direction. Staying flexible at the beginning of the year should allow for more insightful decisions down the road.

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Rethinking Overlay Manager Diversification

Portfolio Solutions - LDI

At LGIM America, we believe overlay manager diversification is likely inefficient and creates uncompensated risks. Using multiple overlay managers can result in increased costs, collateral inefficiency and higher governance burdens.

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