The accompanying comments were submitted as letters to the editor in response to the July 24 editorial, "Hiding not the answer." The editorial suggested the derivatives industry, including many pension funds, money managers, major banks and dealers, and exchanges involved in derivatives, bear much of the blame for contributing to misunderstanding about the instruments because of their lack of openness to discuss their strategies.
The central point of your editorial seems to be that managed futures bring potential added value to institutional portfolios, and both the practitioners and the users should be forthcoming in discussing there attributes. We agree; however, we are realistic enough to know that this will take time.
Institutional investors are understandably reluctant to talk openly with the press about what they are doing in managed futures. The reasons are clear. There are very small rewards for pension plan investment officers and trustees for innovation, and those who introduce new ideas have little to gain from discussing the strategies outside their organizations. This is particularly the case with managed futures because the concept is still considered quite new and controversial. Moreover, certain articles in the press - Pensions & Investments specifically excluded - have done an inadequate job of differentiating between a well-structured institutional managed futures program employing exchange-traded, liquid instruments and the exotic derivatives and unmanaged trading that have created all the highly publicized problems. So the users stay silent or, even worse, make a decision like Kodak's, which appears to be have no obvious investment rationale.
It should be noted, however, that there has been an active educational effort on the part of many of us in the industry. For example, drawing on my many years of experience in traditional investment management before becoming involved in managed futures more than six years ago, I have spoken at myriad investment conferences and forums, including those sponsored by P&I. Moreover, we at Kenmar have responded to every request for information from the press on institutional issues. We also have invited reporters, including those from your publication, to join us for informal luncheons to discuss all aspects of this subject.
Over time, we believe managed futures will demonstrate positive risk reduction, return enhancement and liquidity characteristics when employed in institutional portfolios. This will create a greater level of comfort and openness with the strategy.
David M. Love is president of Kenmar Institutional Investment Management L.L.C., Rancho Santa Fe, Calif.
Don M. Chance
I am writing in response to the apparent misconception underlying your editorial regarding the managed futures industry and my proactive communication relating to derivatives trading. The industry and I personally have strong views not only on the importance of derivatives trading to our economy and risk management capabilities of institutions but also on the importance of accurate education on derivatives. We believe it is essential that the differences between various derivative instruments be understood and the myths that have run rampant in the general press over the past year and a half in response to major losses by certain institutions be corrected. We have embraced any inquiry and would welcome the opportunity to provide you with our views or with hard facts from studies.
As president and chief executive officer of a firm that has traded profitably for more than 25 years in exchanged-traded futures, interbank foreign exchange and other commodity instruments with complete confidence in our ability to manage attendant risks of these investments, I completely agree with the article's support of the potential benefits of managed futures trading. I also view the exit of several viable managed futures clients as unfortunate, especially if based on the recent public misconception of the risks of trading derivatives.
Most of the public misconception stems from the lack of differentiation by the press in reporting the source of major losses that have occurred over the last 18 months. Simply put, the losses are not attributable to managed futures trading and also generally have a little or nothing to do with derivatives trading. The Orange County and Procter & Gamble Co. losses were solely the result of the leverage and investment strategies employed by these institutions. Several articles which made this point were written with the full cooperation of the Managed Futures Association. Unfortunately, initial inaccurate reporting linking these events to "derivatives" has had a powerful effect on the public, and it will take time for our educational efforts to have an impact. While the two pension funds that withdrew from managed futures have been understandably reluctant to discuss their rationale with us or the press, we understand these decisions were due to policy or political issues unrelated to managed futures trading. Due to the visibility of these clients, a prudent decision not to publicly air their reasons for these decisions has led to speculation by some of the press that the decision must be related to lack of confidence in effective risk management of the product. However, as noted in your editorial, the institutions' long-term investment experience with managed futures didn't involve losses. In fact, we believe their managed futures returns for the most part have been comparable or equal to and uncorrelated with S&P returns in the same period.
In this regard, I have initiated and encourage active educational efforts during my tenures as chairman of the Managed Futures Association and as a member of the board of directors of the Chicago Mercantile Exchange, which include distribution of educational materials, formation and funding of a research foundation, presentation of seminars and of education conferences and forums for institutional and public participants as well as educational interviews and forums with the press. The Managed Futures Association has prepared information for pension funds such as the Virginia Retirement System to provide the foundation for rationale investment decisions. Last year in response to an institutional inquiry, the MFA prepared a concise summary and approximately 100 pages of academic literature and the studies and also specifically addressed performance and fee issues. This material support the critical role of managed futures and certain derivatives in risk management and diversification.
While the public may readily understand the difference between a blue chip stock and a penny stock, equity trading historically has not been imbued with the hype and emotional reporting relating to futures investments. The managed futures industry, which has not been involved with any of these major losses, nonetheless has been saddled with the unfair and negative connotation that recently have been broadly applied to "derivatives" trading. The differences between exchange-traded futures and interbank foreign exchange and the trading of complex exotic derivatives are every bit as large as that of blue chip stock and penny stock. Attempting to reverse irrational fears with education is a long, arduous task and the confusion over recent events has made the task far more difficult.
We firmly believe an active managed futures program with proper risk management can enhance the risk and return of even broadly diversified portfolios and will continue efforts to educate the public and press on the benefits of managed futures.
Robert G. Easton is president and chief executive officer of Commodities Corp., Princeton, N.J.
We at the Chicago Mercantile Exchange read with interest your editorial. It lays out your concerns that none of the groups of participants involved in derivatives markets - the Managed Futures Association, the swaps association, the exchanges, or even institutional investors themselves - has adequately explained the benefits delivered by a wide range of derivative products.
While we think we haven't done as badly as you suggest, you and your readers should know that the CME is firmly committed to education about the prudent use of derivatives in risk management and has initiated a number of programs in support of this commitment. Some programs offer testimonials from institutional investors themselves about diversification, hedging, transaction costs, and managing liquidity needs.
Any institutional investor can request, free of charge, an educational packet prepared by the CME addressing these issues. (Call 1-800-331-3332 if you'd like one.) In addition, the CME offers an annual symposium for pension funds that covers these concerns in greater breadth and depth.
We plan to aggressively expand the CME's educational program and to regularly communicate these efforts to you and your reading community. You can be sure we won't be hiding.
John F. Sandner is chairman and William J. Brodsky is president and chief executive officer of the Chicago Mercantile Exchange.
Your editorial raises important questions about communicating matters to the public in regard to derivatives decisions.
The first question in my mind is "should one communicate such private matters?" If Eastman Kodak or the Virginia Retirement System decides to initiate or terminate a derivatives program, is it under some obligation to inform the public? The answer is clearly no. Would it make good sense? Possibly.
I recall when VRS started the program, the Wall Street Journal broke the story, causing considerable public concern. VRS missed an excellent opportunity to allay the public's fears by carefully communicating the nature of its program. But VRS' policy is not to do things like that. That is their right, and they pay the price for it.
The derivatives industry as a whole has done an excellent job of providing information. I am literally overwhelmed by the amount of information I receive on what's going on in the derivatives world.
Given that I am but a lowly college professor in rural Appalachia, I think that speaks highly of the industry. It's too bad Mr. Easton doesn't return P&I's calls but that hardly constitutes an industry-wide problem. And where do you get the idea that "the futures and options exchanges communicate a lot of inconsequential matters?"
Once again, I drown in their communications, which are hardly of an inconsequential nature, and any time I need more information from them, I just pick up the phone. You also mention the International Swaps and Derivatives Association, which, in spite of having globally dispersed members whose interest is the market for certain private transactions, does an excellent job of sharing that information with the public. OK, so it may take a little effort to get it.
Perhaps you should talk to the editors of Risk, Derivatives Week, and Treasury and Risk Management and see why they are not having similar problems.
Don M. Chance is professor of finance and associate director of the Center for the Study of Futures and Options Markets, Virginia Polytechnic Institute and State University, Blacksburg, Va.