Authors Alessandro Beber, professor in finance at Cass Business School and Christophe Pérignon, associate professor of finance at HEC Paris, France, argued, while market commentators are right to question the misuse of derivatives, preventing their use was not the answer.
The 31-page white paper, The Unintended Consequences of Banning Derivatives in Asset Management, said to hinder the asset management industry from using these would have “dramatic implications” for the industry and, most importantly, clients.
The authors claimed: “Derivatives allow investors to get exposure efficiently and cheaply to a specific asset class, to a particular security, or to a specific payoff within an asset class.”
It said the common use of derivatives, such as credit default swaps, within funds meant risks could be diminished. The paper said: “Derivatives allow individuals and firms to achieve payoffs that they would not be able to achieve or could only achieve at much greater cost. More specifically, derivatives can be used to hedge risks and to obtain exposure to an asset class.”
It added: “All the common fears about derivatives use are misplaced for the asset management industry, as the asset manager derivative user is competent and derivative usage is carefully controlled and disclosed.”
| Without derivatives: |
- Risks would be harder to manage, as derivatives allow fund managers to lower their risk exposures - Fund performance would be lower, as derivatives reduce transaction costs and allow access to new asset classes - The investable choice set for final investors would be dramatically reduced - The cost would be particularly high for smaller asset managers, who cannot benefit from economies of scale when implementing alternative risk management strategies. |
Adviser view
Gavin Haynes, managing director for Bristol-based Whitechurch, said: “When used properly derivatives can add significant value, help manage risk and reduce costs in actively managed and passive funds. They are widely used in equity and bond funds, as well as providing the bedrock of the majority of absolute return strategies.”
