Derivatives often part of fund managers' toolkits

Many funds use futures, options and swaps in executing strategies.

Adam Zoll 25 August, 2014 | 6:00PM

Question: The Analyst Report for one of my funds mentions that it uses derivatives. What exactly are derivatives, and how would a fund use them?

Answer: For some investors, the term "derivatives" may have a negative connotation because of the role these complex instruments played in recent financial disasters, including the global financial crisis that followed the bursting of the housing bubble in the United States. But even though this example -- which involved a type of derivative known as credit default swaps -- highlights the potential dangers of derivative use (or misuse), many institutional investors, banks, governments, hedge funds and corporations rely on them as a way to manage risk, pursue hedging strategies and achieve other financial objectives.

Likewise, mutual funds and exchange-traded funds use derivatives in a variety of ways as part of their investment strategies. Some use them to hedge a foreign currency position so that currency movements don't affect the fund's returns, while others will use options contracts to enhance the distributions they provide.

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Adam Zoll

Adam Zoll  Adam Zoll is an assistant site editor with Morningstar.com

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