Putting dampener on derivatives

There is a slight degree of panic creeping in among Europe’s fund managers. While many say Europe’s Ucits III regulations – allowing use of derivative instruments in cross-border funds – are a good thing, not all toe the official line. A PWM event at London’s Cass Business School addressing the use of options, heard asset management SVM’s Colin McLean, one of the industry’s better managers, paint an interesting picture. In his spare time, Mr McLean chairs the UK Society of Investment Professionals and plays an important educational role in the funds industry. Are his members clamouring to find out more about how to correctly use derivatives in their funds? Unfortunately not. In fact the subject barely comes up. And when it does, some members slide down into their seats and try to hide from reality. Only half of UK managers are happy with derivatives, believes Mr McLean. The other part of his membership consists of “those long-only managers who want to see if the whole thing blows over and might collapse.” These sentiments are fuelled by research from Cass’s resident professor of asset management, Keith Cuthbertson. His research suggests using derivatives does not necessarily improve fund performance and can actually reduce it. He believes Ucits III presents a dangerous development, a Las Vegas style free-for-all, with investors gambling money rather than investing it. “Although Ucits III opens up more opportunities for fund managers, we could get to the equivalent of a supercasino of products, proving dangerous to the investor if handled wrongly,” says the professor. Many manufacturers are more positive, of course. Ucits III gives opportunities to market a new set of concepts, such as the 130/30 fund, which allows for some short positions. But private banks also need to be wary of this. In some jurisdictions, wealth advisers requesting particular hedge funds are being fobbed off with 130/30 funds, because the real McCoy has no capacity left. The manufacturers are going back to the banks and saying: “Sorry, our hedge funds are full, but we have something quite similar we can put your clients into.” In many cases, the differences between the strategies are much bigger than any similarities. But let us not put too much of a dampener on Ucits III. To paraphrase Abbey’s head of products, John Kelly, you’ve got to be in it to win it. In other words, there are some market conditions you can not exploit unless you are using derivatives. Yet he also warns distributors: make sure you back-test any funds you select against all type of market conditions. Only in this way can you evaluate the performance promises of the providers.