Mutual fund derivatives exposure nears Rs 2 trn on increased arbitrage play

Turnover share in segment under regulator scrutiny also shows signs of increase since 2018-19

Mutual funds are becoming a larger force in the derivatives segment, accounting for greater exposure by value and as a percentage of the total money they manage.

The net value of mutual fund derivative exposure was Rs 1.9 trillion as of July 2024, according to data compiled by primemfdatabase.com. Aggregate data on mutual fund industry exposure to derivatives is not readily available. The numbers were compiled from disclosures by individual asset managers and shared with Business Standard. This is the highest value in numbers going back to 2018. The money that mutual funds manage has grown in the interim from Rs 23 trillion to more to more than Rs 64 trillion. The share of derivatives, to which mutual funds are allowed exposure only for hedging, has risen to a high of 3 per cent from a low of 1.2 per cent in March 2020 (chart 1). 

Derivatives are instruments that allow investors to bet on the stock market moving up or down. A negative sign indicates short positions or bets on declines used as a hedge to protect downside risk. They can also reflect arbitrage positions. The Securities and Exchange Board of India (Sebi) has proposed to increase the minimum investment to trade in the segment, potentially limiting the participation of smaller investors who along with proprietorships are said to have lost more than Rs 50,000 crore in 2023-24 alone to speculative activity. Reducing individual activity can potentially create room for higher institutional share in the segment.

Mutual funds had a five per cent share on the National Stock Exchange’s equity derivative segment by premium turnover in 2023-24, according to data in Sebi’s annual report. But growth has been relatively fast over the last five years. The 2018-19 figures show 0.4 per cent share in terms of total turnover which can be considered broadly indicative of the activity then. The share of other major players such as foreign portfolio investors (17 per cent from 13.6 per cent in 2018-19) and proprietary investors (40 per cent from 37.8 per cent) has not moved as sharply.

The numbers show that most of the mutual fund exposure is through index and stock futures. They account for over Rs 2 trillion in exposure. Other major kinds of derivatives in which mutual funds have exposure include equity options as well as interest rate swaps.

Hybrid funds, particularly arbitrage schemes, play a larger role than equity funds. Arbitrage funds profit by exploiting differences in the cash and derivatives segment for the same security by buying in one segment and selling in the other. They account for Rs 2.1 trillion in derivative exposure. Equity funds have less than Rs 10,000 crore in exposure while it is Rs 7,500 crore for debt funds.

Sebi recently floated the idea of a new asset class with a minimum Rs 10 lakh investment, which can take derivative bets which are not just for hedging.