SD-05.4 — Overlay & Hedging Management

Business Domain: BD-05 Portfolio Management (Front office) · Applies: BOTH

Purpose

Manages a derivatives book that shapes a portfolio’s aggregate exposures without disturbing its underlying holdings. Overlay & Hedging lets the portfolio’s currency, duration and equity-beta exposures be adjusted, and its tail risk hedged, quickly and cheaply — through futures, swaps and options rather than by trading the physical book. It shapes exposures; closing a structural gap against a liability or total-portfolio target is SD-05.11’s distinct capability.

Service Operations

• Manage currency overlay — hedge or actively manage the FX exposure of foreign-denominated holdings.
• Manage duration and rate overlay — adjust portfolio duration through interest-rate futures and swaps.
• Manage equity-beta overlay — adjust beta and sector exposure through index futures.
• Run tail-risk hedging — protect against extreme events through a dedicated hedge sleeve, an option overlay, or a trend-following overlay.
• Manage portable alpha — gain beta synthetically and deploy the freed capital to an uncorrelated alpha source.
• Run overlay operations — collateral and margin management, mark-to-market, roll management, basis monitoring, and the ISDA / counterparty relationships.

Inputs and outputs

• Inputs: the physical-portfolio exposures and the target exposures; the hedge-ratio policy; derivative market data; the collateral inventory.
• Outputs: the overlay derivative positions, the hedge-effectiveness reports and the collateral and margin schedules.

Entities

• Consumes: Portfolio / Mandate (E-03), Holding / Position (E-04, book = ibor), Price & Market Data (E-08); the derivatives specialisation entities — Listed and OTC Derivative (DR-NN), Margin & Collateral Balance (DR-04).
• Owns: none — the overlay book is recorded as holdings (E-04) of derivative instruments.

Standards

• No single external standard governs overlay management. Currency overlay, duration overlay, beta overlay, tail-risk hedging and portable alpha are the practitioner conventions; the GIPS overlay guidance applies where the overlay’s performance is presented.

Open extensions

• The boundary with SD-05.11 Completion Portfolio Management — both use overlay instruments; SD-05.4 shapes exposures, SD-05.11 closes a structural gap against a target.
• The boundary with SD-05.3 on the rebalancing overlay, and with BD-11 on collateral and margin.