Ask Colin

If trading in options and other derivatives are so good, why do fund manager's even bother investing in shares (excluding voting rights and dividends)?

Your question is what is called a "loaded question". Leaving aside the tricky concept of "good", presumably opposite to "bad", I take issue with your assumption that derivatives are appropriate for fund managers.

The primary reason for the creation of derivatives is to hedge risk. So, the basic reason why a fund manager would use derivatives would be to lay off risk in his or her portfolio of shares.

The other main participants in derivative markets other than hedgers are the speculators and locals, who provide liquidity in return by taking the other side of the risk being hedged.

There are some very complex hedging strategies, including using one derivative to hedge the risk in another derivative.

There are some other strategies fund managers might legitimately use derivatives for, such as boosting portfolio returns though writing covered options. However, this is not entirely risk free.

To trade derivatives only is the role of specialist funds called "hedge funds". Because they reduce the risk of speculation by taking both sides of the risk their profits can be spectacular, but so, too can their losses.

The other problem with derivatives is that they are short term instruments and transaction costs are a significant handicap on results.

Most statistical studies of share investment suggest that holding a long term diversified portfolio of major stocks is hard to beat by all but the most skilful fund managers.

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