Derivatives boost risk-return profile

systematic riskDerivatives add value for investors by both optimising returns and minimising risk, a study has concluded.

The study by Union Investment and Professor Alexander Szimayer of the University of Hamburg, found that in the case of investment funds, derivatives had increased risk-adjusted returns by 0.42 per cent while also lowering systematic risk by 13%.

In terms of risk optimisation, derivatives provided added-value of up to 2% a year for investment funds by various means ranging from arbitrage and market timing to the collection of alternative risk premiums from volatility and liquidity.

Nearly two-thirds of German institutional investors use derivatives and their experiences are “overwhelmingly” positive, the study said.

Swaps are used most frequently, followed by options, futures and forwards. When derivatives are used to manage risk, they are primarily used to hedge market risk, with more than half of all derivatives users employing them to protect against interest-rate risk and currency risk.

When it comes to optimising returns, investors mainly write options in order to collect option premiums, the study found. They also use futures to reduce costs. Some 31% of derivatives users trade volatility as a separate risk factor in order to generate additional returns.

Szimayer said: “Minimising risk using derivatives works in any market phase, even during periods of crisis.”

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