Unmasking Mutual Fund Derivative Use

68 Pages Posted: 15 Sep 2020 Last revised: 1 Dec 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


Utilizing new SEC data enabling us to compute mutual funds' derivative positions performance, this paper studies how derivatives impact fund performance. In contrast to prior research concluding derivatives are used for hedging, we find that most active equity funds use them to amplify market exposure in conjunction with reducing fund equity exposure to market risk. Despite seemingly small weights, derivatives have a significant impact on funds' leverage and contribute largely to fund returns and cross-sectional differences in returns. Funds extensively using derivatives underperform, yet receive more flows. In response to the COVID-19 pandemic outbreak, funds regularly utilizing derivatives trade more heavily on short derivative positions. The pattern is more prevalent among managers for which the risk of recession is likely more salient. There is no change in extensive margin of derivative use. Hedging funds, which are the minority, outperform significantly during the outbreak. Amplifying funds suffer a double whammy. While they do shift strategies, they are slow to react and experience similarly large losses to nonusers in the outbreak phase. By the time they shift, the market has already started to rebound, and they lose on their short positions. Funds are slow to unwind shorts during the recovery. Shifts in derivative return distributions during the COVID-19 crisis are mostly driven by swaps, which have been ignored by previous 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 (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 )

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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