Why invest in derivatives?
Some of our funds may use derivatives for the purpose of Efficient Portfolio Management (e.g. reducing the risk or cost of the fund, or generating additional income or capital). Using derivatives allows the fund to increase or reduce its exposure to the underlying stock market indices, without investing directly in them.
What are derivatives and why are they used?
Derivatives are an alternative investment to stocks and shares, whose value is based on the price of another specified investment. This is done through agreeing contracts with counterparties (usually global banks) to buy or sell those investments at a set price, at a particular date in the future. In other words, derivatives ‘derive’ their price from other investments.
Although the use of derivatives avoids directly investing in stock market indices, the value of the funds will still rise and fall and it is possible to get back less than is invested. The strategy of using derivatives could be riskier than investing directly into stock market indices, so the risk that an investor could get back less than has been paid in could be higher.
These OneFamily funds can invest in derivatives:
- The Family Investments Child Trust Fund
- The Family Asset Trust
- The Family Charities Ethical Fund
- The Family Balanced International Fund
Tell me more about how using derivatives could impact risk?
Leveraging risk
Derivatives can be used to increase the fund's exposure to the underlying stock market indices. The higher the exposure, the more of an impact rises and falls in the indices will have on the overall value of the fund.
If the indices were to increase in value, the leveraging will increase the fund's returns. However, if the indices were to fall in value, leveraging will have the opposite effect, and will increase the effect of any loss. This could result in greater fluctuations in the value of the fund than if the fund had invested directly in the stock market indices.
Counterparty risk
Investing in derivatives involves agreeing contracts with counterparties.
If a counterparty is unable or unwilling to fulfil the terms of the derivative contract (e.g. they promised to buy an investment from the fund for a set price, but then did not have the money to buy that investment) the fund could lose money if the investment then fell in value.
Default risk
Using derivatives means the funds may hold high levels of cash. This cash is deposited with our custodian, State Street Bank. If State Street Bank were to default on the deposited cash, the funds could fall in value.
To reduce the risk of the bank defaulting, we've chosen State Street Bank as our custodian. This is because State Street Bank is an authorised UK deposit-taker who meets our high standard of credit-worthiness.
Questions
If you have any questions about any of the above, please call us on 0844 8 920 920.
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