Greenwich Associates’ 2006 North American Equity Derivatives Study confirms that flow equity derivatives have become ubiquitous among North American institutional investors. Every one of the 113 institutions participating in the study says it now uses liquid “flow” equity derivatives, with 81 percent trading single-stock options, 75 percent trading index options, 74 percent using ETFs, and two-thirds using index futures.
“While the use of all these products is expanding, the next phase of growth for equity derivatives is unfolding in products like equity and variance swaps,” says Jay Bennett, a consultant at Greenwich Associates. “During the 12-month period covered in the study, the proportion of institutions using equity swaps rose from 38 percent to more than half, and the share of institutions using variance swaps on indexes doubled to 20 percent.”
While hedge funds account for much of the volume and growth in several equity derivative products, other types of investors also are integrating derivatives into the fabric of their businesses. Roughly half of self-reported derivative users interviewed by Greenwich Associates are long/short equity portfolios. When it comes to options, hedge funds and mutual funds are the most active users in the United States, while passive funds, pensions and long-only investors in general are the biggest users of futures.
Close to 100 percent of the hedge funds and mutual funds participating in the Greenwich Associates study say they use single-stock listed “vanilla” options, as do approximately two-thirds long-only of investment managers and pensions.
In terms of growth, the proportion of institutions of all types telling Greenwich Associates they trade index options jumped from less than two-thirds in 2005 to three quarters in 2006, with mutual funds the most active segment at 82 percent. The proportion of institutions reporting use of index futures also rose from roughly 60 percent to two-thirds, with pensions far and away the most active users.
But the most impressive growth by far was seen in equity swaps. Greenwich Associates estimates that the 52 percent of institutions that traded equity swaps captured in the study are doing a notional amount of around USD75 billion.
“As the number of users grows, so too does the liquidity,” says John Colon, a consultant at Greenwich Associates. “In turn, as liquidity increases, more institutions feel comfortable using equity swaps not only as an efficient way to hedge, but also as an effective way to take on exposure to certain markets that they cannot access directly under their charters.”
Hedge funds remain the biggest users of equity swaps, with 60 percent of the hedge funds participating in the study identifying themselves as users, up from approximately 45 percent last year. So too in variance swaps and swaps on single stocks. The proportion of institutions surveyed using swaps on single stocks tripled to 12 percent over the 12-month period, but the bulk of that activity is generated by hedge funds.