The SEC’s Department of Economic and Risk Analysis released a study examining registered investment companies’ use of derivatives (which they limit to “futures, swaps, currency forwards, and written options”) and “financial commitment transactions “ (defined as “reverse repurchase agreements, short sale borrowings, and firm or standby commitment agreements or similar agreements”), in conjunction with the Commission’s recent derivatives rule proposal. The study reviewed data from Forms N-CSR and N-SAR supplemented with information from Morningstar for 10 percent of funds registered in 2014.
The paper noted that 77 percent of funds reviewed in 2014 were permitted to use equity options by their investment policies, but only 6 percent did. It also found that 32 percent of funds held at least one derivative position, and currency forwards, equity futures, and interest rate futures were the most commonly used derivatives.
The study also found that the average aggregate exposure to derivatives and financial commitment transactions was 23 percent of NAV. Further, 96 percent of funds had an aggregate exposure below 150 percent, the level at which the proposed rule would curtail derivatives use for most funds. As expected, when looking specifically at “alt strategies” funds (“Alternative mutual funds, Commodities mutual funds, and Nontraditional Bond mutual funds”), the study found increased use of derivatives. The average aggregate exposure for an alt strategy fund was 132 percent of NAV compared to 11 percent for traditional funds. Further, the paper found that 27 percent of alt strategies funds were over the 150 percent aggregate exposure mark compared to 2 percent for traditional funds.
The study found a lower rate of derivatives use in closed-end funds, ETFs, and business development companies at 47, 29, and 0 percent, respectively. None of the closed-end funds reviewed exceeded the proposed 150 percent aggregate exposure limit, but 8 percent of the ETFs did.