17 July 2017

” Protected equity ” – an attractive strategy that requires individualized calibration

" Protected equity " is currently highly popular with investors: In a climate of low interest rates, it provides an attractive solution for taking a position on stock market assets while limiting risk.


[Claire Bourgeois, ALM Director]
However, the choice of an allocation in protected equity must inevitably integrate two criteria – first, the level of risk that the investor is prepared to assume, and, second, the investor’s anticipations concerning the market. Recourse to protected equity is often implemented following individualized analysis.


Protected equity provides a credible alternative, at a time when the environment of the fixed-income markets remains complex. Yields are low, and fixed-income asset classes remain exposed to the risk of a rise in interest rates, given the progressive normalization of the monetary policies of the Fed and ECB. ” Under these conditions, the annualized financial performance of sovereign and corporate bonds could enter negative territory by as early as 2018. Meanwhile, equity still provides appreciable income; but investors are increasingly wary of this asset class, with a prudent bias in favour of ” protected equity,” is how Claire Bourgeois, ALM Director, summarizes the situation. The soar in popularity of protected-equity strategies is also explained by the reduction in the cost of Solvency 2 capital that they can bring, for investors subject to this regulation.


Effective… under the right conditions

However, investment in protected equity requires a rigorous methodology. ” Investors must demonstrate discernment, not only in defining in advance the level of risk exposure and loss that they are capable of assuming, but also in anticipating the costs and effectiveness of the protection attached to this type of strategy,” explains Claire Bourgeois. This is because the specific feature of protected equity is its recourse to optional protection. The cost of protection can be financed by the sale of put options with shorter maturity. It can also be optimized by careful positioning on the volatility curve. ” This can bring down the price of protection, but that price remains onerous: convexity does not come for free.”. The fact is that protection erodes a portion of the dividends on securities. Also, ” choosing to invest in protected equity means accepting to renounce part of the alpha of the managers, if this protection is to be effective,” she adds. ” That amounts to a loss of profit that has be added to the cost of protection.”

Consequently, investors cannot escape the need for careful reflection on the yield target and optimal profit of their portfolio, in a framework of predefined risk. The challenge is to define the right balance and to make intelligent use of arbitrage between directional equity and protected equity, in order to achieve appropriate allocation. The first stage consists in choosing the suitable strategy in terms of acceptable risk. ” Between an investor prepared to assume a fall of 15% and another prepared to accept a fall of 25%, the former is likely to have more to gain from resorting to protected equity. This is because the probability of a 15% decline over 10 years is higher than for25%. So, the protection will be more cost effective,” explains Claire Bourgeois. The second stage is based on detailed study of stock market predictions. This analysis plays an active role in the decision whether or not to protect the investor’s equity exposure. ” Clear vision of the underlying risk perspectives remains essential. Market forecasting is a dynamic factor in determining whether there is a need for protection,” adds Claire Bourgeois. ” A very high or very low forecast on the equity market will lead to a high allocation in protected equity, whereas anticipation of a market with no extreme trends will not exactly constitute an argument in favour of a high proportion of protected equity.” 

So, the integration of protected-equity strategies in asset allocation remains ” conditional “. These strategies are perfectly suited to the framework of established investment based on a genuine approach of financial engineering. Therefore, asset managers have an important advisory and supporting role to play for institutional investors in order to design optimal portfolios.



This document is for information purposes only.

Groupama Asset Management and its subsidiaries are not liable for any modification, distortion or forgery of this document.

All information contained in this document is confidential and reserved for the exclusive use of its addressees.

Any unauthorized modification, use or distribution of all or part of this document, by whatsoever means, is prohibited.

The information contained in this publication is based on sources that we consider to be reliable, but we do not guarantee its accuracy completeness, validity or relevance.

This document was drawn up on the basis of information, projections, estimates, forecasts and hypotheses that involve a degree of subjective judgement. The analyses and conclusions express an independent opinion formed on the basis of publicly available information on a specific date and by applying a methodology specific to Groupama AM. In view of the subjective and indicative nature of these analyses, they cannot be construed to constitute a legally binding commitment or guarantee by Groupama AM or as personal financial advice.

This non-contractual document does not, under any circumstances, constitute a recommendation, request for offers, an offer to buy or sell or an arbitrage offer, and may in no case be interpreted as such.

The commercial teams of Groupama Asset Management and its subsidiaries are at your service if you wish a personal financial recommendation.