Completion overlays can be thought of as an extension of traditional overlay management to include a more granular focus: countries, regions, sectors, styles, etc. Recall our example above of a fund’s alpha-seeking tilt toward European equities. While traditional analysis may show developed international equity as on target, a significant tilt toward Europe may introduce unintended risks relative to the benchmark.
The chart below illustrates how a completion overlay would seek to reduce this bias by removing beta exposure to Europe and adding exposure to a corresponding underweight region (Japan, for example), often via futures. This structure is intended to loosen capital constraints, allowing for allocation of capital to preferred managers while using an overlay to complete the policy asset allocation. The result is a significant mitigation of unintended risks, a retention of expected alpha, and an improvement in portfolio flexibility.
Source: Parametric. For illustrative purposes only. Chart does not represent actual performance results
Beyond country and regional exposures, investors may want to manage at the style, sector, or factor level. In these situations a completion sleeve may be most efficient. For example, consider a portfolio with an unintended bias toward growth equities. A completion manager can analyze holdings to determine the extent of the growth bias and create a sleeve consisting of value companies to offset this bias, as illustrated below. The completion manager will regularly monitor the overall portfolio in an effort to maintain tracking error and other key portfolio characteristics within certain parameters.
Source: Parametric. For illustrative purposes only. Actual portfolio allocation and sizing of completion sleeve may vary.
Growth and value styles are a basic example of a completion sleeve application. Factors such as earnings quality, dividend yield, volatility, momentum, and profitability can all be managed within the same sleeve. These factors can be maintained as part of a benchmark completion or as active tilts based on investor decisions. Organizations with a focus on ESG can also use completion sleeves to help align a portfolio with particular missions or beliefs.
The bottom line
By loosening constraints and unlocking previously untapped potential, completion management can not only help improve monitoring and analytics but also enhance portfolio flexibility—and, given the right allocation of capital, even increase return expectations.
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