Producing alpha is the Holy Grail of active investment management, and most people attempt to generate returns exceeding a benchmark index by relying on hands-on stock or bond picking. And when people think of investment alpha, they often dream of achieving outsized returns well above the benchmark.
The folks at Liquid Strategies LLC have a different take on the pursuit of alpha that has nothing to do with active stock or bond selection, or with generating boffo alpha above the benchmark. The Atlanta-based investment management firm this week rolled out the Overlay Shares suite of five actively managed exchange-traded funds that employ an options overlay strategy over a specified benchmark index. The strategy is designed to create additional returns above a benchmark over time with little change in the overall risk profile.
The Overlay Shares ETFs take a minimalist approach to portfolio construction: four of the five funds in the suite contain just one holding in the form of an ETF that tracks a specific index for either stocks or bonds, depending on the fund’s objective. The fifth product has two underlying ETFs. The Overlay Shares roster comprises the following:
• Overlay Shares Large Cap Equity ETF (OVL)
• Overlay Shares Small Cap Equity ETF (OVS)
• Overlay Shares Foreign Equity ETF (OVF)
• Overlay Shares Core Bond ETF (OVB)
• Overlay Shares Municipal Bond ETF (OVM)
The large-cap OVL fund illustrates how the options overlay strategy works. This fund takes a 100% long position in large-cap equities via its lone holding, the Vanguard S&P 500 ETF (VOO). It also sells short-term put options on the S&P 500 Index with a notional value (i.e., strike price times the value of the shares) up to 100% of the fund’s net assets and buys an equal number of short-term put options with a lower strike price. The fund aims to capitalize on the inefficiency of options pricing by generating income via the “put spread” between these options.
“Our overlay is strictly a premium collection mechanism where we collect an incremental premium from our overlay,” says Brad Ball, co-founder and CEO of Liquid Strategies. “We give you all of the returns of the underlying index, plus the incremental overlay on top of it.”