Download Use of derivatives in multi asset

The use of derivatives in multi asset
This sales guide is for Professional Clients only
and is not for consumer use
The Invesco Perpetual Global
Targeted Returns Fund is a
fund of investment ideas.
These investment ideas are
sourced from a wide array
of asset types, geographies,
sectors and currencies.
The team is able to implement
some of these investment ideas
through the use of derivatives.
This is an incredibly important tool
that our Multi Asset team aim to
utilise in the fund for (1) efficient
portfolio management (income
enhancement or risk reduction)
and (2) for gaining investment
exposure to asset classes.
Futures
Why use derivatives
The term derivative means that the value
of the instrument is derived from an
underlying security or index. For example,
a US Treasury future is a derivative of the
US Treasury market, a FTSE 100 Call option
is a derivative of the FTSE 100 index, and
an interest rate swap is a derivative of an
underlying interest rate market.
Financial derivatives can be used for:
Managing risk
An efficient way to add or reduce risk
to a portfolio
I mplementing a short position
Enables an investor to take a negative
view on a market
Swaps
Modifying exposure
For efficient tactical asset allocation
Reducing costs
Transaction costs tend to be lower than
for the underlying asset to which the
derivative relates
Options, volatility and variance
Using derivatives in
multi asset investing
Futures
Derivatives can be seen as quite a
risky and complex way of investing,
but used properly and with the right
controls, the Invesco Perpetual Multi
Asset team believes that derivatives
can substantially help reduce
risk in a multi asset portfolio.
Futures involve a contract to buy or
sell a fixed quantity of a particular
commodity, currency or security for
delivery at a fixed date in the future
at a fixed price. Unlike an option,
a contract involves an obligation
(not an option) to purchase or sell
and can generate indeterminate
losses; especially where futures
are traded on margin, losses can
significantly exceed the cost of the
initial investment.
Types of derivatives that could be
used in the Invesco Perpetual Global
Targeted Returns Fund
The fund has the ability to invest in a
broad range of financial instruments,
including derivatives. The combination
of traditional assets and derivatives
helps the fund managers to build a highly
diversified portfolio.
For the purpose of this derivatives guide,
we will explain futures, swaps and also
take a look at options, through implied
volatility and variance.
Futures, swaps and options can be applied
to most asset classes including equities,
bonds and currencies. The examples shown
are for educational purposes only and are
not representative of the current portfolio.
A futures contract, as an obligation,
can only be closed by cancelling
out its effect by buying or selling a
futures contract with the opposite
effect. The clearing house dealing
with the exchange will then net off
(contra) both contracts to ensure
a nil balance on the investor’s
account. Futures provide a vehicle
for hedging and for speculators
who provide markets with liquidity.
Futures contract
In practice: avoiding market beta
and isolating alpha
The team could take a view that some
companies or sectors in a particular region
offer good opportunities, but given the
continued volatility in many markets
the team may not want exposure to the
broader market risks.
To avoid these risks, the team could use
futures to hedge the market beta and
isolate the skill of an active fund manager
at a stock selection level (alpha). This
removes the risk present at a market level,
which if left could substantially add to the
volatility of the fund.
Isolating alpha
If you think
prices will go up
Long
Sell
Exchange
Buy
Short
FTSE 100
Future
Clearing house
Alpha
UK Fund
Equity
If you think
prices will fall
Source: Invesco Perpetual, for illustrative
purposes only.
02
The use of derivatives in multi asset
Source: Invesco Perpetual, for illustrative
purposes only.
Swaps
Options, volatility and variance
Generally, a swap is an exchange
of payments between two parties
(sometimes called counterparties),
directly or through an intermediary.
An option is the right, but not the obligation, to buy (call option) or sell
(put option) an investment holding at a predetermined price (called the
exercise price or strike price) at, or before (for certain option types),
a particular date in the future.
Two examples of swaps:
(i)currency swap: an agreement between
two parties to exchange future payments
in one currency for payments in another
currency, in order to eliminate currency
risk. At maturity of the swap contract,
the principal must be exchanged.
(iI)interest rate swap: an agreement
between two parties such that one
party pays the other a fixed interest
rate in exchange for a floating interest
rate at predetermined intervals.
The interest rate is calculated on an
agreed amount, the ‘notional principal
amount’. In contrast to the currency
swap, this principal is not exchanged on
maturity of the contract.
In practice: pinpointing exposure
The team could take a view of interest
rates in a particular market. If they believe
interest rates are currently too high versus
where the team expects them to be over
time, that idea can be implemented directly
using the Swaps market. Swaps allow
flexibility in how to pinpoint exposure within
markets, whereas often the underlying
bond market doesn’t provide that degree
of flexibility or opportunity to target such
precise exposure.
The team is able to implement investment
ideas more effectively, by gaining specific
exposure that may not have been available
though direct investment in the underlying
asset class.
The price of an option represents the cost (premium) of the right to
buy or sell an underlying security at a given price and its time value. The
price will vary depending on the prospects of changes in the price of the
underlying security to which it relates. If a traded option is unsuccessful
the buyer simply allows the option to lapse and only loses the initial cost.
In practice: using volatility as an
alternative source of returns
Options allow the team to take a view on
market volatility. Volatility refers to the
amount of uncertainty or risk about the size
of changes in a security’s value. A higher
volatility typically means that a security’s
value moves dramatically more frequently.
This means that the price of the security
can change significantly over a short time
period in either direction. A lower volatility
typically means that a security’s value does
not fluctuate dramatically, but changes
in value at a steady pace over a period of
time. The volatility that a security displays
over time is the security’s realised volatility.
Implied volatility is reflected in the price
of options and represents the market’s
view of volatility in the future. If there is an
increase in demand for options, their price
tends to rise which reflects a view that
investors are expecting more volatility
over time. The team can look at the level
of implied volatility, i.e. what the options
market is telling them about volatility and
then take a view on whether the current
level of implied volatility is too high or too
low relative to where they expect it to be.
Interest rate swap
Call option (long)
If you think
rates will fall
Gain
Fixed
receiver
Source: Invesco Perpetual, for illustrative
purposes only.
03
Strike price
The use of derivatives in multi asset
If you think
volatility will rise
Variance
swap
buyer
Premium
If you think
rates will rise
By trading volatility through the use of
options and variance swaps, the team can
build diversification against more traditional
assets such as equities and bonds and also
provide the potential for an alternative
source of returns.
Variance swap
Fixed Fixed
payer
Floating
Another way of taking a view on both
realised and implied volatility is through
a variance swap. Variance enables an
investor to isolate exposure to volatility
and have no exposure to the direction of
underlying market moves. This means
variance is priced differently to options
which are priced based upon a single strike
price. If the team expects volatility to rise
they could buy a variance swap which
provides a direct way of taking a view on
the difference between the current price
of volatility (implied volatility) and what
volatility actually does over time (realised
volatility). A variance swap becomes
profitable if the level of realised volatility
rises above the level of implied volatility.
Asset price
Loss
Source: Invesco Perpetual, for illustrative
purposes only.
Variance
swap
seller
Implied
volatility
Realised
volatility
If you think volatility
will fall
Source: Invesco Perpetual, for illustrative
purposes only.
Contact us
UK Retail Sales
Telephone 01491 417600
Email [email protected]
UK Institutional Sales
Telephone 02075 433541
www.invescoperpetual.co.uk/investinginideas
Telephone calls may be recorded.
Important information
This sales guide is for Professional Clients only and is not for consumer use.
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.
Where Invesco Perpetual has expressed views and opinions, these may change.
The Invesco Perpetual Global Targeted Returns Fund makes significant use of financial
derivatives (complex instruments) which will result in the fund being leveraged and
may result in large fluctuations in the value of the fund. Leverage on certain types of
transactions including derivatives may impair the fund’s liquidity, cause it to liquidate
positions at unfavourable times or otherwise cause the fund not to achieve its intended
objective. Leverage occurs when the economic exposure created by the use of
derivatives is greater than the amount invested resulting in the fund being exposed to a
greater loss than the initial investment.
The fund may be exposed to counterparty risk should an entity with which the fund
does business become insolvent resulting in financial loss. This counterparty risk is
reduced by the Managers, through the use of collateral management.
The securities that the fund invests in may not always make interest and other payments
nor is the solvency of the issuers guaranteed. Market conditions, such as a decrease in
market liquidity for the securities in which the fund invests, may mean that the fund may
not be able to sell those securities at their true value. These risks increase where the fund
invests in high yield or lower credit quality bonds and where we use derivatives.
For the most up to date information on our funds, please refer to the relevant fund
and share class-specific Key Investor Information Documents, the Supplementary
Information Document, the first Interim Short Report and the Prospectus, which are
available using the contact details shown.
Invesco Perpetual is a business name of Invesco Fund Managers Limited
and Invesco Asset Management Limited
Perpetual Park, Perpetual Park Drive, Henley-on-Thames Oxfordshire RG9 1HH, UK
Authorised and regulated by the Financial Conduct Authority
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