About EPO
Institutional investors typically invest the institution’s assets relative to specific equity benchmarks that comprise the institution’s strategic policy guidelines. Some institutions gain this exposure through the use of passive strategies that replicate major equity indexes. Others use multiple active managers that collectively resemble a broad based index. Rampart’s Equity Program Overlay (EPO) investment program, driven by the Rampart Options Management System (ROMS®), can help institutions monetize stock and market volatility. It provides for increased utilization of the underlying investment vehicles, whether it is a passive investment vehicle or a collection of active managers, by identifying and selling call options appropriate to the underlying asset(s) in a systematic and disciplined manner to generate additional income. (If the institution has sufficient equity assets, call options can be sold on individual positions—effectively implementing CSO at the portfolio level.)
An interactive dialogue with institutional investors and their consultants is an important aspect of our investment approach. Each institutional investor has unique risk/return requirements and is exposed to different investment vehicles based on the structure and equity allocations of their investment program. Therefore, each prospective institutional client typically requires customized modeling of their existing investments to aid in determining an appropriate Equity Program Overlay.
The first step of our investment approach is an analysis of the institution’s investments. In cases where institutions seek to gain the beta exposure to various equity classes passively, Rampart reviews the institution’s holdings information and analyzes the optionability of the particular exposures using a ROMS-generated Indicative Program Opportunity (IPO) projection. These exposures are generally static and expressed relative to widely recognized benchmarks, like the S&P 500, Russell 2000, MSCI EAFE, or MSCI Emerging Market Free indexes. This is ideal for an Equity Program Overlay. Income from an EPO can be used for distributions or to meet a spending rule obligation; in the case of core/satellite structures, the income might be ported to a higher risk/return active strategy.
Upon completion of the analysis, Rampart uses the resulting Indicative Program Opportunity (IPO) projection for illustrative purposes to discuss potential results of incorporating an overlay strategy with the institutional investor. A key discussion point is the inverse relationship between the Target Price (the price above which the investor forgoes upside appreciation) and the institution’s income objective; the higher an institution’s income objective, the lower the Target Price. It is important that the institution understands this trade-off – there may be an opportunity cost (the upside may be truncated) if the index that Rampart is writing calls on appreciates beyond the selected Target Price.
In cases where the institution is using multiple active managers to outperform an equity class, Rampart works with the institution in a similar fashion as previously described. It is important to note, however, that applying an Equity Program Overlay to actively managed underlying portfolios or commingled funds, introduces the potential of tracking error or basis risk. While the Rampart strategy might be effective at reaching the income goal, the aggregate investment program may not be as successful if the underlying investment vehicles do not outperform their asset class benchmark.
