A discussion of Optimizing Portfolio Hedging Strategies was held with Neil Dissanayake who is a Senior Risk Manager & Trader with Milliman and Alessandro Esposito, Convertible Portfolio Manager at BlueBay Asset Management.
Dissanayake began the presentation talking about the embedded optionality that exists in the portfolios of insurers. He says most insurers have risk that cannot be tied to a single risk factor – they often have equity, interest rate, and volatility risks. Typically with respect to retirement guarantees and insurer’s risks are long term but they need short term market liquidity as well. He spent several slides discussion the decision between hedging through replication or option purchases. He noted that using options compared to pure replication is typically more favorable when considering tail risk.
Esposito followed with a presentation where he made a case for consistent hedging, optimizing hedging strategies, sizing initial trades and managing positions over time, and cross asset hedging. He starts out saying that hedging is primarily about adding the convexity to a portfolio. He shows that consistently buying a put results in underperformance relative to the underlying market. His example was buying 95% puts on the S&P 500 every three months. He notes that the ultimate success of a hedging program is going to be based on the volatility of the underlying portfolio. A very interesting statement he made was, “the complexity of the payout increases the predictability of the hedged strategy.” He finished up saying that VaR methodologies can be used to compare hedges including cross asset hedges.