Risk Premium Strategy

The GMO Risk Premium Strategy seeks to generate a total return over the long term commensurate with that of global equity markets primarily by writing put options on U.S. and non-U.S. stock indices.

GMO believes that put selling enables investors to generate equity-like returns in a manner that is relatively insensitive to equity market valuations and also that allocating across global markets increases the opportunity for adding value. Put sellers are compensated by collecting what amounts to an insurance premium. In contrast, equity owners are compensated by the earnings yield of the market. Since both activities take equity risk, utilizing both put selling and owning equities can achieve diversification via an increased opportunity set. Furthermore, the relative attractiveness of the approaches varies – selling puts is an attractive proposition when insurance premiums are high, while owning equities is attractive when earnings yields are high, and these do not have to be coincident.

We believe the use of the CBOE S&P 500 PutWrite Index is appropriate for measuring the Strategy’s ability to generate returns by gaining exposure to the global variance risk premium; however, we also consider performance against the MSCI World Index over long time horizons to evaluate the Strategy’s ability to harvest the global equity risk premium.