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Possible innovations in
Mutual Funds opportunity
zone
By – MANISH BANSAL
SEBI
Covered warrants
Financial Institutions including Mutual
Funds (MFs) are sitting on tons of
securities. Through the creative use of
derivatives, specially options, institutions
may unleash the value creating
opportunities from these idle securities.
Covered warrant may be one such
product.
Covered warrants
Covered warrant is a variant to the covered call
strategy.
Covered call strategy is writing call options
backed by the underlying shares.
Therefore, covered warrant is call option written
by the issuer backed by the underlying shares.
This warrant is separately listed and traded on
the exchanges.
Underlying is locked till the exercise/expiry of the
warrants.
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Huge untapped opportunity for Mutual Funds lies in
the covered call strategy itself.
Covered warrants
Value drivers:
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As the writing of options fetches money to the
Mutual Funds, it delivers the values in the
following two manners:
Reduction in the cost of acquisition of the
underlying securities.
It helps generating money for institutions and
their investors, while holding the underlying.
Covered warrants
Mutual Funds may also write naked
warrants (call and put both). Of late, these
cash settled warrants have become
popular in the global markets.
In this case, as underlying is not there with
the writer of option, to protect the interest
of the investors, exchanges would margin
the short position of these Mutual Funds.
Covered warrants
Products like index warrants and basket
warrants are being architected by the
market, at the global level. In India, there
lies a titanic opportunity for Mutual Funds
in these areas.
Covered warrants
Final proposal:
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Mutual Funds may write both call and put warrants.
Product may be cash settled or delivery based.
Both the covered and naked warrants may be written
by Mutual Funds.
Underlying for the warrant may be anything like
equity, debt or any other hybrid product.
As Mutual Funds are the writer/seller of options,
having obligation to perform the contract, they will
either lock their underlying (in case of call warrants)
or put the required money in a separate account (in
case of put warrants) or pay margin to the exchanges
(in case of naked warrants).
Other innovations…
Mutual Funds may create and/or invest in the
products linked to:
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Commodities
Currency
Bullion etc.
We may have all vanilla products and specialized products
like options and exotic structures in these areas.
Direct investment in currencies, commodities and bullion may
also be explored by the Mutual Funds (Say gold fund or
wheat fund).
Other innovations…
Debt ETFs – Following a specific index in the fixed
income market.
Collateralized Debt Obligations/ Collateralized
Mortgaged obligations – Securitization of assets offers
the tremendous opportunities to the Mutual Funds in
these areas.
MFs may link themselves to the Credit Cards. Mutual
Funds units may assume the position of the Virtual
Cash, over the period of time, in all dimensions of life.
Trading of Credit derivatives (both purchase and sale).
Mutual Funds may be allowed to create credit derivatives
at the same time purchase credit derivatives. Therefore,
they may run a credit derivatives portfolio with suitable
disclosures in the offer document.
MFs may launch the stripped products.
Other innovations…
MFs may launch the structured products like
combination of floaters and inverse floaters and
CMO kind of structures.
MFs may become the Securities Bank – lending
Securities to the market participants.
MFs may create synthetic products to trade say
different underlying. For instance, trading of
dollar with the help of the Difty and Dollax.
Mutual Funds may use FRAs and Swaps for
strategic trading.
Other innovations…
Following ideas may be experimented with:
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Derivatives Funds
Arbitrage Funds/Opportunity Funds
Derivatives Funds are visualized to take
strategic positions in the derivatives market to
create values for their investors.
Arbitrage Funds/ opportunity Funds are
expected to shop across the cash and the
derivatives markets to exploit the mis-pricing i.e.
arbitrage opportunities, to create values for their
investors.
Disclosures in the document
Relevant disclosures with regard to the
trading strategies of the funds and
inherent risks in the schemes would be
made in the offer document.
Value drivers
An opportunity for Mutual Funds Industry
to widen the products base.
Opportunity to the small investors to
participate in the derivatives market.
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The big contract size of the derivative
products.
Lack of specialized knowledge on the
subject.
Opportunity for the derivatives market to
have wider participation.
Value drivers
Arbitrage Funds would be less risky than
the Vanila Mutual Funds.
These products would spark the
innovation in the Mutual Funds Industry
and help it unleash its creativity and
imagination.
Regulations…
Final onus of the operations of the Mutual Funds
lies with the Trustees and with their fiduciary
capacity they are assumed to be exercising their
prudence while allowing any scheme.
Regulations would ensure the transparency and
proper disclosures to the investors.
Regulations would also bring the certain degree
of discipline among the participants in the
market.