Geographic tilt creates risk for derivative investing
Investors should be aware that exchange traded derivatives are generally tilted towards geographies where derivative products originated, which can affect the portfolio’s basis risk.
Speaking at Frontier’s annual conference, Donna Davis, Frontier consultant, said there had been a big push in Europe for derivatives tied to environmental, social and governance (ESG) investing which relied on underlying definitions of ESG that differed from many Australian definitions.
“[You] should have a think about what are the key responsible investment principles that are very important to you and very important to your portfolio, and then find out how you want to align [them],” Davis said.
“Are you looking to equitize cash in your portfolio and are you looking for a derivative that's kind of an overlay or a completion? Do you have a particular view on something such as carbon?”
She said the best option for Australian derivative investors wanting to maintain an underlying alignment to their holdings would be a bespoke solution.
“If you are going to do that though, you just need to be aware that if it's over the counter traded, you don't have as much price transparency as you would in an exchange contract,” she said.
“So doing a price comparison or having a look at the fees associated with the products being offered to you can be a little bit more challenging.”
She advised investors to shop around with brokers and derivative sellers and to perhaps get a consultant involved to break down the fees and terms and conditions, as well as the investor’s portfolio and the level of alignment of the product.
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