The Use of Derivatives by Investment Managers and Implications for Portfolio Performance and Risk

48 Pages Posted: 15 Jul 2005

See all articles by Kingsley Y. L. Fong

Kingsley Y. L. Fong

University of New South Wales - School of Banking and Finance

Aaron Ng

UNSW Australia Business School, School of Banking and Finance

David R. Gallagher

Bond University

Date Written: July 1, 2005

Abstract

This study provides an empirical examination of derivative instruments used by institutional investors. Our analysis provides a unique insight into the role of derivative securities within portfolios, and the potential benefits from their use. We contribute to the literature using a database that comprises the periodic portfolio holdings and daily trades of active equity managers. The consequence of derivative use is analyzed using a number of performance and risk measures. Overall, we find the use of derivatives have a negligible impact on fund returns. This finding is attributed to low levels of derivative exposure relative to total fund size. We also evaluate how derivatives are used by considering the trading strategies executed by investment managers. The option trading patterns of active institutional investors are shown to be consistent with the execution of momentum trading strategies. The study also documents that active investment managers prefer not to use options markets to engage in informed trading.

Keywords: Derivatives, managed funds, investment performance, portfolio risk

JEL Classification: G11, G23

Suggested Citation

Fong, Kingsley Y. L. and Ng, Aaron and Gallagher, David R., The Use of Derivatives by Investment Managers and Implications for Portfolio Performance and Risk (July 1, 2005). Available at SSRN: https://ssrn.com/abstract=756184 or http://dx.doi.org/10.2139/ssrn.756184

Kingsley Y. L. Fong (Contact Author)

University of New South Wales - School of Banking and Finance ( email )

UNSW Business School
High St
Sydney, NSW 2052
Australia

Aaron Ng

UNSW Australia Business School, School of Banking and Finance

Sydney, NSW 2052
Australia

David R. Gallagher

Bond University ( email )

Centre for Data Analytics, Bond Business School
Gold Coast, QLD 4229
Australia

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