GREENWICH, Conn. - Fixed-income derivatives trading volume plummeted among pension funds, investment managers and mutual funds, a Greenwich Associates report shows.
In addition, the share of trading in exchange-traded futures and derivatives among investment managers and mutual fund managers fell, although pension funds' share held steady, the survey shows.
But the results don't surprise institutional investors.
In a survey of many types of institutional derivatives users, pension fund use of interest rate and cross-currency swaps fell to $100 million on average from $6.2 billion; investment manager use fell to $100 million on average from $1 billion; and mutual fund use fell to $100 million on average from $6.1 billion.
Pension fund use of interest rate options, caps, collars, floors or swaptions among survey respondents rose to $500 million on average from $100 million, while investment manager use fell to $800 million on average from $2.2 billion, and mutual fund use fell to $300 million on average from $600 million.
Pension funds' share of futures and exchange-traded fixed-income derivatives volume held steady at 13%, while investment managers' share fell to 15% from 21%, and mutual funds' share fell to 12% from 34%.
Frank Feenstra, principal with Greenwich, said the big derivatives-linked losses taken in the past few years woke up a lot of senior people at institutional investment firms to the realization that they didn't know how derivatives were being used. Because the firms didn't want to get burned, they curtailed the use of all derivatives, he said.
The number of users also declined, with smaller investors possibly getting out for good, Mr. Feenstra said. The cost of managing positions and understanding what they're doing might be too great for smaller investors, he said.
The Greenwich survey results confirmed what some institutional investors have seen in the derivatives markets.
"I'm not at all surprised by the survey," said John Isaacson, chief investment officer for Payden & Rygel Investment Counsel, Los Angeles. The results are consistent with his experience in 1994 and 1995.
"We just got a steady stream of calls" from pension sponsors looking at how to define derivatives in order to limit their use, he said. A problem with that, though, is that new structures are constantly being created, and using a definitional method of limiting their use will not work, he said.
In addition, many investors were at least rewriting investment guidelines, if not banning derivatives' use, he said.
For clients who requested it, Payden & Rygel has increased its reporting to clients on derivatives usage.
But he had a message for clients: "Don't get rid of derivatives if it can truly reduce volatility."
At Payden & Rygel, portfolio managers have not altered their use of derivatives in response to losses, Mr. Isaacson said. Derivatives are used primarily for hedging currency positions.
Robert Arnott, chief investment officer and chief executive of First Quadrant Corp., Pasadena, Calif., said he isn't surprised by the drop in volume among pension funds and money managers in using over-the-counter derivatives.
He said the decline "is probably, in fact almost certainly, happening in the OTC swap market, where some of the exotic custom-designed fixed-income swaps and other over-the-counter derivatives have turned out to be so costly - indeed, devastatingly costly to some institutional investors who did not have the sophistication to fully understand what they were buying.
"But we have seen no evidence at all of a decline in interest in using exchange-traded bond futures - plain-vanilla derivatives - where the daily settlement of gains and losses makes it much more difficult to get into serious trouble unexpectedly building up losses over months."
William Miller, chairman of the End Users of Derivatives Association, a Washington education and resource group for derivatives users, noted other factors - like a less volatile interest rate environment - might have contributed to decreased use of derivatives.
If interest rates don't move as much, there's less of a need to use derivatives to try to limit volatility, Mr. Miller said.
He also said if derivatives use by pension funds and investment managers has fallen as overall use increases, maybe those investors should question whether they are managing risk properly.
Some institutional investors, who asked to not be identified, wondered if the Greenwich study was a good reflection of how pension funds and money managers use fixed-income derivatives, particularly given the continued growth in the overall use of OTC derivatives.
The Greenwich survey included 1,110 institutions overall, including 96 pension funds with internal management, 449 investment managers, and 97 mutual funds.
