The derivatives market is experiencing growing adoption among both institutional and retail investors as awareness and education about the asset class continues to grow, says Shawn Creighton, director of index derivatives solutions at FTSE Russell.
“I think [investors are] a bit more comfortable understanding how derivatives can fit in their specific financial portfolio, whereas before they were concerned. . . . You see derivatives becoming a lot more mainstream, especially options, whereas before some of these products were primarily geared towards [institutions].”
Derivatives as an investment are a financial contract with unique terms for the underlying asset that can be bought or sold — the value is entirely dependant on the asset. This investment is typically employed by institutional investors as a portfolio efficiency tool, says Creighton.
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“You’re not going to see [institutional investors] using derivatives for a speculative type of outlook . . . [Instead], it’s more relevant than it has been in recent history, [these investors are] using derivatives to hedge interest rate risk.”
The Office of the Superintendent of Financial Institutions defines the prudent use of derivatives as a way for plan administrators to implement risk management strategies that can reduce asset or funded status risk associated with variability from exchange rates, interest rates, market indices or commodity prices.
Derivatives offer investors the ability to lock in a fixed rate or a floating rate via interest rate swaps, depending on the strategy at-hand ultimately aiding the liability side for pension fund investors, he adds.
Following the global financial crisis, derivative assets became predominantly available in over-the-counter markets but now he’s seeing more of these assets come to regulated exchanges. This transition alongside a savvier retail investor class is creating more interest, he says.
Read: Ontario judges’ group sues pension plan sponsor to prevent investments in derivatives
Earlier this month, the Association of Ontario Judges said an investment plan proposed by the Provincial Judges Pension Board, which includes derivative products, would violate an agreement with the province to avoid investing in these assets.
The AOJ is insisting derivatives generate undue risk and is against the trade and investment of derivative products like swaps, credit defaults, repurchases, forwards, futures, options and other types of derivative contracts tied to various indices and equity or debt instruments.
Looking ahead, Creighton expects more asset classes that were traditionally traded off exchanges will become available through derivatives, like fixed income and foreign currency. “As the technology evolves, the more complex products are going to be more accessible for people to trade.”