Institutional investors looking to take advantage of market volatility should consider taking the unusual step of writing index put options, according to US institutional investment manager Neuberger Berman.
Super funds and other institutional investors are usually on the other side of options transactions, buying index puts as insurance against their exposures.
But Eric Knutzen, multi-asset class chief investment officer at Neuberger Berman, says that since the financial crisis the number of counterparties willing to provide investors with insurance by writing put options has fallen, as regulatory pressure has forced investment banks out of the market.
“Long-term institutional investors have a role to play here because they can manage the liquidity issues involved in this market,” Knutzen says.
Neuberger Berman has tracked the additional return that investors can earn from the premium income generated by writing puts against the S&P 500 index. Over the 27 years since 1990 the CBOE S&P 500 PutWrite Index has produced an average return of 9.6 per cent a year, compared with an average return of 9.4 per cent for the S&P 500 index over the same period.
Knutzen says institutional investors need to cast their nets wider in the hunt for diversification, and left-field options strategies are one of a number of alternative strategies Neuberger Berman has been working on.
Neuberger Berman shares the consensus view that global securities markets are experiencing a sea change, with a shift from the post-GFC central bank-led recovery to fiscal stimulus as the driver.
While some investment houses see this as a straightforward growth story, Knutzen says this change will be accompanied by volatility. “Growth will not be even across assets and regions,” he says.
“Investors are faced with significant challenges. Return expectations are historically low, while there is heightened market uncertainty spurred by geopolitical and economic regime shifts.
“That makes for a difficult choice. Investors can lower their expectations or they can add risk. Our view is that they should be looking at using some different tools to deal with a more complex risk environment.”
Neuberger Berman estimates that a typical 70/30 long equity and long bond portfolio will return about 100 basis points less each year over the medium term than investors have been used to in recent years.
Knutzen says that to counter this institutions need to consider a wider range of alternatives.
– John Kavanagh