PIMCO Advises Investors to Embrace Options Market

(March 5, 2012) — Portfolio managers would be better off using options to more effectively anticipate different market environments, according to Josh Thimons, executive vice president and portfolio manager at fund giant Pacific Investment Management Co. (PIMCO). 

Options allow portfolio managers to express a specific view conditional on the direction of the market, Thimons concludes in a recent paper. 

According to the paper, the performance of most investments over the coming months will likely depend directly on the outcome of the European debt crisis. “Often overlooked as an asset class and traditionally used to hedge other risks, options – puts and calls whose prices depend on the level of implied volatility – exist in virtually all major markets. In the current turbulent market, we see opportunities to construct portfolios using options that can potentially benefit in a myriad of possible outcomes in Europe,” Thimons asserted, noting that most users of options tend to be large market participants hedging business risks. He continues: “Rather than choosing whether Europe will improve or deteriorate, options can be used in such a way that they kick in only if Europe improves or deteriorates.”

He concludes that investors can “potentially prosper even if they admit that the outcome in Europe and the timing of that outcome are anything but certain.” Therefore, according to PIMCO, options are one tool that allows investors to admit a lack of omniscience and prosper amid uncertainty. 

With PIMCO’s overall encouragement about the benefits to investors of using options amid an uncertain market environment, how are institutional investors using them, and more importantly, are they using them effectively? 

While there is still a general concern among institutional investors about effectively using options, schemes are increasingly using these investment vehicles to hedge against interest-rate risk, many consultants say. Mercer consultant Gordon Fletcher noted he has witnessed a much greater interest in derivatives among corporate funds as they look into derisking strategies amid an environment of frozen legacy liabilities. “We’ve seen a growing number of especially corporate pensions using derivatives as they pursue liability-driven investment,” Strategic Investment Solutions’ Managing Director John Meier told aiCIO. “If you’re trying to lower pension surplus interest rate risk, using derivatives is definitely effective in order to maintain a reasonable level of return.”

Meanwhile, according to Jeffrey MacLean, the CEO of Seattle-based Wurts & Associates, most large institutional investors at the portfolio level utilize options without relying on the use of investment consultants, due to the deep expertise needed to implement such strategies. “Implementing tail risk hedging strategies requires experience that you do not often find with traditional consulting firms…For Plan Sponsors with internal staffs capable of placing tail risk hedges on the portfolio level, it is important for them to have the right governance structures in place to properly implement them.”   

MacLean continued: “If you’re using options to implement tail-risk hedging, for example, you want someone who has done it for lots of years and understands all the complexity — having someone doing it on a part-time or non-discretionary basis does not make sense.”

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