Mostly… fixed income and cross product eTrading

May 11, 2007


Filed under: Nuts and Bolts — holky @ 6:41 am

A survey (Financialnews and RD/IR) from March regarding buyside policy on the use of derivatives shows that nearly a third of buyside do not use derivatives now, and the majority of the non-users have no intention to start.

  • 23% – Do not use and no intention to do so
  • 7% – Do not use now, but do intend to use in the future
  • 23% – Occasionally allow fund managers to use
  • 25% – Often allow fund managers to use
  • 22% – Allow all fund managers to use

With reference to Sean’s post about financial derivatives how much of that “no – never!”  is down to not actually understanding the product sufficiently to utilise derivatives as part of an investment (or indeed ‘insurance’) strategy to actually achieve what they genuinely need? 



  1. I’d say completely Holky. Also depends on who the “buyside” are, in terms of type & size.

    Comment by waratah — May 11, 2007 @ 11:16 am

  2. “completely” is naive. How does XYZ Investment Management Ltd. influence the consultants to influence the trustees to open a mandate to derivatives??

    Yes, some buy sides lack the technology, people and processes to handle derivatives, but often that’s in response to the expressed wishes of their clients.

    And if you are investing for a long term – say a pension fund for a 20-30 year old ages cohort – would you say that derivatives – IN THE REAL WORLD – are a sensible investment???

    Comment by John Greenan — May 11, 2007 @ 1:33 pm

  3. surely if a single product is made available that can mitigate the level the risk you take while either delivering (if you are investing) or without destroying (if you are insuring) the returns you get for having that business in the first place, why shouldn’t this be a sensible option to consider in all cases, regardless of what the moving parts in the agreement are derivations of?

    do all trustees and the underlying clients seek to constrain the fund mandate on the basis of their full understanding and rejection of the other products/tools in question, or is it sometimes because of a lack of trust for the fund to correctly use and so exploit those potentially-quite-complex products in order to get it right? (or perhaps rather to avoid the horror story of “getting it spectacularly wrong”)

    Comment by holky — May 11, 2007 @ 3:23 pm

  4. Put yourself into the shoes of a pension trustee. Do you give £10billion to a “respected” investment manager with a “solid track record” of “long term equity investment” or do you give it to some super duper clever chap who mutters about Cox-Rubenstein, Fischer & Myron (on first name terms!) and Monte Carlo…

    I am not disagreeing with your premise; merely indicating that having worked with pension trustees and pensioneer trustees that there is an understandable reluctance to invest in non-traditional investment products.

    But you have missed the second part – what value do derivatives pose for genuinely long term investment – if you are looking at a pension fund for a 20-30 year old age cohort then you want risk.

    I do not agree with “financial weapons of mass destruction” but how many buy sides have the skills to really manage these things? How many buy-sides work out margin calls by just giving the custodian whatever they ask for? How many buy sides that trade single name CDS even know what they really have bought or sold protection on? How many buy-sides have the technology to look at VaR for an investment portfolio and work out 95% 1 day loss. How many buy-sides even have a first idea about this stuff. And if you think that the buy-side does not know then how the heck will pension trustees?????

    My preference for describing derivatives is a bit like fast cars. Just because you can get in the seat and start the engine does not mean you can handle a Porsche 911 at 180mph on the Nurburgring in the wet. Most trustees trust themselves to drive a Ford Mondeo at 70mph and that’s it.

    Until the clients – the trustees – have a great deal of confidence in all moving parts of the system they will not use derivatives and not trust investment managers to use them. The volatility, lack of exchange trading and clarity all mean that trustees are not happy to allow investment managers to buy derivatives.

    So, it’s a combination – trustees do not trust themselves, trustees do not trust investment managers.

    Comment by John Greenan — May 11, 2007 @ 4:16 pm

  5. John, what is naive is for a Buyside respondent to say “never”. What makes it more shocking is that it is 23% – but as I said it depends on what type of buyside/asset class etc.

    I’m fully aware that mandates have limitations and that Trustees are far from Investment Professionals, however the true mark of understanding is to be able to explain something to people with no background in the subject and make them understand….at least to some extent.

    There has been a huge growth in derivative use by “long only” managers obver the past 3-4 years, and growing. These 23% who claim they will “never” use derivatives may be out of a job in the near future. If not, when there is some derivatives based loses in the future they’ll say “I told you so”, even though they’ve underperformed their peers by 200bps a year and have only 25% of their original AUM.

    It is a derivatised world, no doubt, and only going to become more so. I can see similar surveys showing less & less in the “No, Never” camp as the years roll by.

    Comment by waratah — May 21, 2007 @ 12:56 pm

  6. I think you are making a different point there Waratah. I agree – over time the “no, never” camp will quite probably decrease in time – this is consistent with what I see in the market place.

    Take another view – I go buy a car – do I pay much attention to the salesman or do I go on my own research and talk to people who already drive that model? Being able to understand this and explain it has a minimal impact…

    But – again – what value do derivatives pose for genuinely long term investment – if you are looking at a pension fund for a 20-30 year old age cohort then you want risk?

    Comment by John Greenan — May 22, 2007 @ 10:35 am

  7. Thing is John, having worked on that side of the market, 20-30 performance figures are not what is looked at. It is 5, 3, 1 year & quarterly figures.

    Using derivatives to smooth returns over time has to be a good thing I’d have thought? Even if the end result is the same.

    Comment by waratah — May 22, 2007 @ 2:01 pm

  8. I understand the 1,3,5 & quarterly figures focus. But when it comes to education (your earlier point) why not try and educate the trustees that they should focus on the long term and that short term “smoothing” is a waste of time??

    I’m not a luddite, raging against the machine; I simply see little value in investing long term money in short term assets – the only winners seem to be the investment banks selling the derivatives…

    But I am enjoying this debate – always good to hear other views and opinions!

    Comment by John Greenan — May 23, 2007 @ 1:01 pm

  9. Indeed.

    I’d say it is more the consultants than the Trustees themselves. In my experience the Trustees just do what the consultants tell them.

    As I said before, the value isn’t necessarily in the form of greater long term returns, rather smoother short-term returns.

    Comment by waratah — May 24, 2007 @ 3:49 pm

  10. […] Following on from previous post on derivatives, Financial News claims Fund managers (representing 100 of the largest European Asset Management […]

    Pingback by Derivatives « Mostly… — July 24, 2007 @ 6:06 am

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