Demystifying Derivatives: How Equity, Fixed-Income, and Asset Allocation Mutual Funds Employ Derivatives.

Sammanfattning

After the 2008 crisis and the COVID-19 pandemic-related financial downturn, attention to the use of derivatives by mutual funds has increased both from investors and regulatory bodies. This paper uses SEC N-PORT and CRSP data on equity, fixed-income, and asset allocation mutual funds from 2021 to 2023 to investigate the primary use case of derivatives by these mutual funds. We find that while equity and asset allocation funds primarily use derivatives to amplify returns, fixed-income funds use them mainly for hedging risks. We also show how all 3 types of mutual funds use derivatives on a contract level. Equity funds tend to use equity derivatives for amplification and use foreign exchange and credit derivatives for hedging. On the other hand, fixed-income funds mainly utilize foreign exchange and interest rate derivatives for hedging. Asset allocation funds use foreign exchange derivatives for hedging and interest rate derivatives for amplification.