OIC highlights options opportunity for pensions
22 June 2018 Chicago
Image: Shutterstock
The opportunities that exchange-listed options could represent for pension and endowment investors are highlighted in a short note published by Joseph Cusick, director of institutional education and business development, at the Options Industry Council (OIC).
Cusick suggested: “If pensions and endowments do not manage to become fully funded, they risk not meeting in full their obligations to millions of pension plan participants.
The funding shortfalls aren't new.”
But Cusick said that what has changed is the fact that a number of these institutions are turning to a variety of alternative investments to increase returns, “in doing so, they are, at times, potentially magnifying the risk in their portfolios.”
“Yet many are missing an opportunity in one of the more defensible places to search for improved risk-adjusted returns: the exchange-listed options market, he added.
He cited data gathered by Greenwich Associates and commissioned by the OIC. The data indicate that 40 percent of pensions and endowments are currently considering private equity as an investment.
While some 36 percent are contemplating illiquid credit investments that do not have an active secondary market where they can be traded. Such investments include leasing, asset-backed securities and distressed debt.
By contrast, only 16 percent of pensions and endowments are thinking about exchange-listed options, even though options have far greater real-time price discovery, transparency and reduced counterparty risk.
Options also allow institutional investors to design outcomes with readily available loss-mitigation strategies. Cusick pointed out that this contrasts with the view being taken by other asset managers.
Almost half of those surveyed by Greenwich are already considering future investments in exchange-listed options. Only 10 percent are considering private equity.
“To the extent that such strategies improve the risk-return profile of a given fund, the cumulative effect over time could be significant,” cautioned Cusick.
Options are not without risk, he conceded, but what is often ignored is that when options are properly understood and deployed, they can offer investors what is actually a conservative approach to generating income.
For pension funds, they may even provide a way to lessen the 12-percentage-point funding shortfall for corporate funds shown by Greenwich data or the 20-percentage-point gap for public funds (as of 2017).
Risk diversity is another key driver supporting their utility, Cusick said.
As the non-linear risk and return characteristics of options differ from linear assets such as stocks and bonds, the addition of options can expand the efficient frontier of an optimal portfolio.
Also, the ability to improve yield on a portfolio is a powerful incentive for asset managers to explore all available tools.
However, the attraction of exchange-listed options appears to be much less pronounced for pensions and endowments than it is for other asset managers.
On average, those firms which invest in options have 16 percent of their assets under management invested in option strategies, the Greenwich Associates data show. Pensions and endowments average only 7 percent exposure.
Cusick concluded: “The divergence is somewhat surprising because the potential to generate income with defined risk from a portfolio should be a strong draw, especially for underfunded pension plans.”
Cusick suggested: “If pensions and endowments do not manage to become fully funded, they risk not meeting in full their obligations to millions of pension plan participants.
The funding shortfalls aren't new.”
But Cusick said that what has changed is the fact that a number of these institutions are turning to a variety of alternative investments to increase returns, “in doing so, they are, at times, potentially magnifying the risk in their portfolios.”
“Yet many are missing an opportunity in one of the more defensible places to search for improved risk-adjusted returns: the exchange-listed options market, he added.
He cited data gathered by Greenwich Associates and commissioned by the OIC. The data indicate that 40 percent of pensions and endowments are currently considering private equity as an investment.
While some 36 percent are contemplating illiquid credit investments that do not have an active secondary market where they can be traded. Such investments include leasing, asset-backed securities and distressed debt.
By contrast, only 16 percent of pensions and endowments are thinking about exchange-listed options, even though options have far greater real-time price discovery, transparency and reduced counterparty risk.
Options also allow institutional investors to design outcomes with readily available loss-mitigation strategies. Cusick pointed out that this contrasts with the view being taken by other asset managers.
Almost half of those surveyed by Greenwich are already considering future investments in exchange-listed options. Only 10 percent are considering private equity.
“To the extent that such strategies improve the risk-return profile of a given fund, the cumulative effect over time could be significant,” cautioned Cusick.
Options are not without risk, he conceded, but what is often ignored is that when options are properly understood and deployed, they can offer investors what is actually a conservative approach to generating income.
For pension funds, they may even provide a way to lessen the 12-percentage-point funding shortfall for corporate funds shown by Greenwich data or the 20-percentage-point gap for public funds (as of 2017).
Risk diversity is another key driver supporting their utility, Cusick said.
As the non-linear risk and return characteristics of options differ from linear assets such as stocks and bonds, the addition of options can expand the efficient frontier of an optimal portfolio.
Also, the ability to improve yield on a portfolio is a powerful incentive for asset managers to explore all available tools.
However, the attraction of exchange-listed options appears to be much less pronounced for pensions and endowments than it is for other asset managers.
On average, those firms which invest in options have 16 percent of their assets under management invested in option strategies, the Greenwich Associates data show. Pensions and endowments average only 7 percent exposure.
Cusick concluded: “The divergence is somewhat surprising because the potential to generate income with defined risk from a portfolio should be a strong draw, especially for underfunded pension plans.”
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