MANY PENSION FUNDS AVOID DERIVATIVES ANALYST URGES INVESTOR EDUCATION

MANY PENSION FUNDS AVOID DERIVATIVES ANALYST URGES INVESTOR EDUCATION

World pension funds are expected to reach $11.2 trillion by 1999, but many of the senior investment officers from insurance companies and other institutions don't even use a dollar of this money for derivatives.

The pension fund assets, which heavily involve insurance companies, are projected to grow by an annual average of 9.8 percent from the 1994 total of $7 trillion, an industry survey predicts. The survey by the London-based Intersec Research Corp. also estimates that the size of European pension

funds, which at the end of 1993 stood at $1.5 trillion, will expand to $2.3 trillion by 1999.The survey, which is based on more than 700 interviews with senior investment officers from pension funds, insurance companies, banks and investment managers, however, found that a large number of the companies surveyed did not use any structured derivatives such as futures, options, and other derivative instruments.

Intersec Vice President Steven Oxley told an international audience of exchange executives attending the annual Swiss Commodities Futures and Options Association meeting in Burgenstock this aversion will be countered only if the institutional world overcomes its fear and misunderstanding of derivatives.

He noted that the review showed that approximately 77 percent, or a staggering $255 billion of foreign currency exposure by pension funds in Europe were not hedged, even though studies show that hedging lowers the volatility of portfolios.

He added that only 9 percent of the currency funds were fully hedged, and a similar amount were partially hedged. Mr. Oxley said that the proportion of accounts that could invest overseas but were not currency hedged stood at 89 percent for Denmark, 85 percent for the United Kingdom, 79 percent in France, 75 percent in the Netherlands, 69 percent in Switzerland, and 64 percent in Germany.

Only 19 percent of European pension funds on average used exchange-traded derivatives, although the level varied from a low of 4 percent in Germany, and 9 percent in France, to 36 percent in the Netherlands, 33 percent in Switzerland, 16 percent in the United Kingdom and 10 percent in the United States.

The most frequently used traded derivatives instruments by the pension funds were equity products, 69 percent, foreign currency, 26 percent, and short- and long-term interest rates with 24 percent, respectively.

European pension funds that did not use derivatives gave a variety of reasons. The top six reasons for "derivophobia" were: approximately 58 percent said they felt no need to use them, 55 percent of respondents also identified restrictive investment guidelines as a hinderance, 37 percent legal restrictions, 34 percent poor understanding of derivatives within management, 28 percent general negative perception, 24 percent negative press.

Mr. Oxley said that there was a need for a more in-depth understanding of derivatives and a need to educate institutional investors, and pointed out that better and understandable information from the industry along with better public relations could help.

The image problem confronting the industry was underscored by the response given by 215 pension funds and insurance companies using derivatives in continental Europe.

From this sample of users 64 percent said they agreed derivatives can distort markets, 62 percent of senior management don't understand derivatives, and 81 percent agreed trustees/investment committees don't understand derivatives.