Overlay
Derivatives such as futures, forwards or swaps held alongside a portfolio to change an exposure without trading the physical holdings. Often run by a specialist, for hedging, rebalancing or active return.
Where you will meet it
Overlay appears in 10 learning outcomes on the CFA syllabus. A few of them:
- Explain the tools available to manage liquidity risk in a portfolio
“Further tools are credit lines, derivatives overlays that adjust exposure without selling illiquid holdings, secondary sales of fund interests and slower new commitments.”
- Set out the strategic choices in implementing an allocation, including how passive or active to be and which vehicles deliver each type of mandate
“Passive exposure can be delivered through index mutual funds, exchange-traded funds, separately managed index accounts, or derivatives such as futures and total return swaps, which also allow overlays.”
- Explain the approach known as liability-driven investing
“Implementation uses long bonds, cash flow matching, immunisation or overlays with swaps and futures.”
- Illustrate how derivatives serve in asset allocation and rebalancing and in extracting market expectations from prices
“Futures change a fund's mix quickly and cheaply without disturbing the managers of the physical assets: shifting from equities to bonds means selling equity futures and buying bond futures, and an overlay can restore target weights between scheduled rebalancing dates.”
See also
Practise it
Practise overlay until it is automatic: questions that explain every wrong option.
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