Julius Baer offers alternative to options hedging

Switzerland’s Bank Julius Baer is expanding its equity product range by introducing investments that give downside capital protection by imitating options hedging on a portfolio.

The Zurich-based bank’s new ‘Flex Allocator’ products use constant proportion portfolio insurance (CPPI), a hedging technique that splits an investment into risky and risk-free assets, and regularly rebalances the weighting in line with the delta of a replicated option.

“Options are very expensive due to the low interest rate,” said Markus Gonseth, Zurich-based head of the bank’s private banking unit. “And if you use options you are limited in time.”

Bank Julius Baer is marketing two products, which are being sold to fund managers as well as private clients. Its ‘Flex 90’ guarantees 90% of the invested capital will not be lost, with 25% of the investment exposed to the equity markets and the remaining 75% allocated to fixed-income investments. The ‘Flex 80’ comes with 80%-capital protection and an equity quota of 75%, with the remainder in fixed income. Flex 80 is aimed at “growth-oriented” investors, said a bank official.

Flex Allocator investments have no set maturity since they are structured as deposits, but Bank Julius Baer said an investment horizon of at least several years and a minimum investment of Sfr2.5 million (€1.7 million) is required.

Due to the limited number of underlyings – and other constraints such as time-to-expiry – on put options, dealers have devised alternative hedging strategies. One of these is portfolio insurance, which involves replicating options hedging by trading the underlying equity and fixed-income instruments. The portfolio is regularly rebalanced by buying one and selling the other, in line with the delta of the replicated option.

CPPI uses this technique but simplifies the process – rather than using complex mathematics to work out the exact delta, it approximates the delta by defining it as a constant multiple of the difference between the portfolio level and a pre-defined floor level.

Gonseth said he expects to sell several hundred million Swiss francs worth of the Flex Allocator during the next year.