Fund managers and their institutional clients will step up investment exposure in derivatives over the next few years, senior figures at a recent industry gathering have concluded.
The general consensus by close of play at Using Options in Fund Management, an FT Mandate event held this month at the Cass Business School in London, was that there was every reason for derivatives to be part of the investment strategy of large institutions, if money managers and trustees are sufficiently educated on the implications of doing so.
Expert views swayed back and forth over the merits of using derivatives, such as options, not just for big investors like pension funds but also at a retail investment fund level.
“Those that do not use options, rather than those that do, will be the ones feeling left out,” said Richard Bolchover, director of Close Fund Management and chairperson for the event.
In agreement, the opening address from Howard Flight, founder of Guinness Flight Investment Management and former British Conservative party spokesman, talked of derivatives being “a natural part of fund management”. He added: “I want my pension fund to get more aggressive as I get older, not the other way round”.
Speaking about the risks of using derivative instruments, especially for the less sophisticated investor, Mr Flight claimed it was more dangerous not to consider exposure to derivatives. “The risk to the public investor is greater in a long only strategy than in going short,” he warned.
Philip Gocke, head of institutional investors at the Options Industry Council (OIC), explained that in the US, it is endowments and hedge fund money driving net growth in the options market, not cash from pension funds. “We need to continue to educate and train institutional money on the pluses of using derivatives and we are finding the willingness to do so,” noted Mr Gocke.
Some of the most active players in the US options market, as a result of their activity in absolution return strategies, are Ivy League universities. OIC research found 23.3 per cent of Yale University’s $18bn (€13.7bn) endowment fund invested in absolute return strategies. Harvard puts 15 per cent of its $29.2bn endowment money into absolute return strategies.
Attentions now turned to what the implications for the retail investment industry might be, should the use of derivatives become as mainstream as predicted on the back of Ucits III regulation.
Guy Monson, chief investment officer of Sarasin, a private wealth, charities and pension funds manager, said “a revolution was taking place”, and that it was “impossible to unwind the clock” in terms of retail investment funds incorporating derivatives in their products.
“The potential for retail investment funds to enhance returns, reduce risks, and provide flexibility through using derivatives was huge,” claimed John Kelly, head of client management at UK high street bank Abbey.
Dipping a toe in
On a cautious note, Colin McLean, chairman of the UK Society of Investment Professionals and chief executive of SVM Asset Management, reckoned options, for example, would continue to be under-owned by many large UK institutions. “Perhaps UK fund managers and their clients will dip their toes into simpler derivatives products before going down the options road,” noted Mr McLean.
The first real note of scepticism of the day came from Keith Cuthbertson, professor of asset management at Cass Business School. The professor considered the impact Ucits III would have on the retail funds market, via exposure to derivatives, as although opening up more opportunities for fund managers, “could prove dangerous to the investor if handled wrongly”.
Discussions returned to pensions and charities and how, if at all, they should integrate derivatives into their risk and investment management mandates.
James Bevan, chief investment officer of CCLA Investment Management, explained that trustees should look for independent price verification if they choose to buy options. “There is no point using over-the-counter options if the guy who evaluates them is also the person who supplies them,” he said.
Mr Bevan believed that trustees should allocate sufficient time to studying derivatives, so as to avoid any costly mistakes, although easier said than done. “The problem is that many trustees don’t have the hours in the day to give to their pension funds,” he added.
There were a number of senior trustees of major UK schemes in attendance at the event, including Colin Grindle, head of pensions, at Lloyds TSB, and Trevor Burrows, senior trustee of the Thorn pension scheme.
“Options are not de rigueur in absolute circumstances,” concluded Mr Bevan.
Ros Altmann, a leading UK consultant, said institutional investors should, logically, take the lead established by corporate finance and treasury in how they use derivatives to smooth liabilities and manage risk. “The use of options is commonplace in corporate treasury and many companies and financial institutions use contracts to hedge against borrowing or lending exposure, so why don’t corporate pensions?” queried Dr Altmann.
NM
