Long-only asset managers in the US are increasingly taking positions in equity derivatives, according to a new study by Tabb Group, a research and advisory firm.
The study, ‘Equity Swaps and OTC Options 2008: A Buy-side Perspective’, found that a growing range of investment firms are trading equity derivatives.
“While it may be no surprise that nearly 50% of hedge funds today trade equity swaps or OTC options, a growing number of asset managers, including long-only fundamental shops, indexers and private wealth divisions of regional banks, hold sizable equity derivatives positions as well,” said Adam Sussman, director of research at Tabb and author of the study, in a statement.
While OTC options that closely resemble to listed options are used by the same asset managers that trade their listed equivalents, the Tabb study found that nearly 40% of the firms trade exotic options – forecast to rise to 45% by end of year 2009 – and that nearly 70% trade total return swaps. The continuing growth in global equity derivatives, which has experienced a 27% compound annual growth rate across both listed and OTC derivatives since 1999, is being spurred by the buy-side’s need to create differentiation, according to Tabb.
However, buy-side firms need to be wary when trading OTC options, according to Sussman. “To access the advantages of equity swaps and OTC options, the buy-side must first navigate an opaque market structure,” he said. While pricing is a key determinant for trading with a firm, “There’s little information for the buy side to figure out a fair price.”
The study also found that the continuing global credit crisis is affecting the buy-side’s trading of OTC derivatives. Some 57% of the US buy-side firms surveyed said the main impact of the crisis is an increased focus on counterparty risk.
“Over 50% of all asset managers are tightening the process around measuring and managing counterparty risk,” said Sussman. “Large buy-side firms will limit significant exposure to a particular investment bank. Investment banks are pulling back capital, thus forcing smaller funds to look elsewhere for liquidity and service.”
The Tabb research is based on interviews with 32 asset managers, including 17 investment managers and 15 hedge funds, trading an aggregate of $6.35 trillion dollars of assets under management.