Article

Risk Management – Macro Overlays

April 8, 2021
Lyndon Man
Lyndon Man
Fund Manager
Invesco Global Investment Grade Corporate Bond Strategy
Invesco Global Investment Grade Corporate Bond Strategy

Risk management occurs at every stage of the investment process; whether undertaking a complete assessment of market conditions before implementing a theme or optimising the positioning of the theme through valuation models (i.e. momentum & econometric), units of risk (i.e. tracking error, duration times spread) and theme characteristics (i.e. interest rate sensitivity measures & return correlation) to achieve the desired level of diversification.

In addition, the team expects that credit markets will experience bad periods and implement tail risk hedges, named ‘macro overlays’. In managing the portfolios, they use highly liquid derivatives to try and reduce downside capture during periods of corporate bond weakness; they do this using currency forwards, interest rate futures, options and credit default swap (CDS) on indices (where investment guidelines permit). These macro overlays can be modulated to varying degrees depending on the risks identified, whilst acknowledging that unidentified risks may exist.

For instance, during periods of risk off, corporate bonds tend to exhibit a negative price correlation in comparison to their government bond counterparts. Therefore, in order to try and reduce the downside capture of the Strategy during periods of corporate bond weakness, they can tactically use interest rate futures to increase duration. This means that they do not have to trade in and out of the underlying bonds to reduce exposure to the market which can be costly. By using derivatives to help manage the mark to market risks of the strategy it allows the team to keep the investment themes intact and continue to hold the corporate bonds they want to own over the long term, rather than selling them only to try and purchase them back in future.

Trading in and out of corporate bonds can be costly, especially during periods of risk off, and there is no guarantee you will be able to buy back the bonds you sold. Therefore, implementing macro overlays using derivatives allows them to more efficiently modulate the risks within the strategy. If you would like to know more about macro overlays, please click here.

The result of this approach, we believe, is compelling for three reasons:

  1. Potential outperformance of the global investment grade corporate bond universe if correctly identifying investment themes and constructing these around the benchmark accordingly
  2. Potential high participation in up markets whilst mitigating negative returns in down markets using macro overlays
  3. Attractive risk adjusted returns, a potential by-product of achieving the previous two points. 

Related insights

  • The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.

    Debt instruments are exposed to credit risk which is the ability of the borrower to repay the interest and capital on the redemption date. The strategy may use derivatives (complex instruments) in an attempt to reduce the overall risk of its investments, reduce the costs of investing and/or generate additional capital or income, although this may not be achieved. The use of such complex instruments may result in greater fluctuations of the value of a portfolio. The Manager, however, will ensure that the use of derivatives does not materially alter the overall risk profile of the strategy. Investments in debt instruments which are of lower credit quality may result in large fluctuations in value.

    As this strategy is invested in a particular sector, you should be prepared to accept greater fluctuations of the value than for a strategy with a broader investment mandate.

    Changes in interest rates will result in fluctuations in value.

    The strategy may invest in contingent convertible bonds which may result in significant risk of capital loss based on certain trigger events.

    Investment in certain securities listed in China can involve significant regulatory constraints that may affect liquidity and/or investment performance.

  • Where individuals or the business have expressed opinions, they are based on current market conditions, they may differ from those of other investment professionals and are subject to change without notice.

    This document is marketing material and is not intended as a recommendation to invest in any particular asset class, security or strategy. Regulatory requirements that require impartiality of investment/investment strategy recommendations are therefore not applicable nor are any prohibitions to trade before publication. The information provided is for illustrative purposes only, it should not be relied upon as recommendations to buy or sell securities.