Unmasking Mutual Fund Derivative Use During the COVID-19 Crisis

53 Pages Posted: 15 Sep 2020

See all articles by Ron Kaniel

Ron Kaniel

University of Rochester - Simon Business School; CEPR

Pingle Wang

University of Texas at Dallas, Naveen Jindal School of Management, Department of Finance

Date Written: September 14, 2020

Abstract

Utilizing newly available data from the SEC on derivative performance and detailed derivative holdings, this paper studies how derivatives impact mutual fund performance, with an emphasis on the COVID-19 pandemic period. In contrast to previous research concluding derivatives are used for hedging, we find that most active equity funds use derivatives to amplify market exposure. Despite the seemingly small weight, derivatives have a significant impact on funds' leverage and contribute largely to fund returns. In response to the initial outbreak of COVID-19, funds trade more heavily on short derivative positions. This behavior is more prevalent among managers residing in states with early state-level Stay-at-home orders, where the risk of recession is likely more salient. Funds that used derivatives for hedging purposes before the crisis significantly outperform nonusers by over 9% during the initial outbreak, as their distribution of derivative returns shifts to the right. By the end of June, they still outperform by 1.6%. On the contrary, funds that used derivatives to amplify market exposure underperform, and their distribution of derivative returns shifts to the left. While they do shift strategies, they are slow to open short positions and remain mostly amplifying funds. Consequently, by the time they shift, the market has already started to recover, so that they lose on their short positions. The shifts in derivative return distributions during the COVID-19 crisis are mostly driven by swap contracts, which have been ignored by prior studies.

Keywords: COVID-19, Derivatives, Mutual funds,

JEL Classification: G01, G11, G12, G14, G23

Suggested Citation

Kaniel, Ron and Wang, Pingle, Unmasking Mutual Fund Derivative Use During the COVID-19 Crisis (September 14, 2020). Available at SSRN: https://ssrn.com/abstract=3692838 or http://dx.doi.org/10.2139/ssrn.3692838

Ron Kaniel

University of Rochester - Simon Business School ( email )

Rochester, NY 14627
United States

HOME PAGE: http://rkaniel.simon.rochester.edu

CEPR ( email )

London
United Kingdom

Pingle Wang (Contact Author)

University of Texas at Dallas, Naveen Jindal School of Management, Department of Finance ( email )

800 West Campbell
Richarson, TX 75080
United States

HOME PAGE: http://www.wangpingle.com

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