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Exchange-Listed Options Mean Opportunity for Pensions and Endowments
Traders Magazine Online News, June 28, 2018
Pensions and endowments continue their efforts to become fully funded. If they don't bridge their gaps, they risk not meeting at least part of their obligations to millions of pension plan participants, including school teachers, police officers and firefighters.
The funding shortfalls aren't new. But what has changed is the fact that some of these institutions are turning to a variety of alternative investments to increase returns, and in doing so 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.
A number of pensions and endowments, which oversee hundreds of billions of dollars, are now attempting to address underfundedness by investing in areas such as illiquid credit instruments, venture capital or private equity. The table below, based on research conducted by Greenwich Associates and commissioned by The Options Industry Council, indicates that 40% of pensions and endowments are currently considering private equity as an investment, while 36% are contemplating illiquid credit investments that do not have an active secondary market where they can be traded - areas like leasing, asset-backed securities and distressed debt. Presumably, these are viewed as offering an acceptable risk profile.
Meanwhile, according to Greenwich, only 16% 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.
What about other asset managers? Almost half of those surveyed by Greenwich are already considering future investments in exchange-listed options, while only 10% are joining their pension and endowment colleagues in considering private equity.
The research suggests that generally, the pension and endowment community has overlooked the exchange-listed options market and strategies that have a demonstrated ability to improve risk-adjusted returns and mitigate risk, even as they actively seek out the parts of the financial markets universe where genuinely complicated instruments dwell.
On average, firms investing in options have 16% of their assets under management invested in option strategies. Pensions and endowments, in contrast, average only 7% exposure. To the extent that such strategies improve the risk-return profile of a given fund, the cumulative effect over time could be significant.
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