Derivatives: A brave new world for planners

As the clients’ wealth grows, so must the expertise of financial planners and investment advisers. That’s because clients have more financial planning and investment options available to them, and often more-complex financial problems needing solutions.

And thanks to the strength of the equity markets between 1982 and 1999, client wealth has grown dramatically. One result has been an increase in the number of clients demanding more from their financial advisers than a simple portfolio of mutual funds.

Nevertheless, I was surprised two weeks ago to run into several financial planners at the Risk Management Conference in San Diego, sponsored by the Chicago Board Options Exchange, the Chicago Board of Trade and the Chicago Mercantile Exchange.

From past experience at this conference, I knew most of the attendees were money managers, executives of brokerage firms or pension funds, corporate treasurers, or endowment or foundation officials.

Those organizations generally have large-enough amounts of assets to make the use of derivative securities a viable proposition. They also have sufficient staff to have a derivatives specialist or two.

The conference covered such exotic topics as “Volatility, Skew and Tail Risks,” “Market-Neutral Investing,” “Enhanced Indexing” and “Managing Credit Spread Risk.”

The attendance of financial planners at the Risk Management Conference confirmed that the world of financial planning is becoming more difficult. Planners are being asked to help resolve more-complex financial problems.

For those planners, the conference also held eight sessions designed to introduce them to derivatives, or even to refresh the memories of those who had once studied and perhaps used derivatives such as put and call options or stock index futures, but who had allowed their knowledge to go stale.

Some topics of the eight sessions were, for example, “Futures Market Fundamentals,” “Options Market Fundamentals” and “Basic Interest Rate Futures Applications.”

networking

One of the planners at the conference, a 20-year veteran, was engaged over dinner with one of the conference speakers, professor Carl Luft of DePaul University in Chicago, in a discussion of possible solutions to a client’s unusual problem.

Mr. Luft spent several minutes reminding the financial planner of how put and call options could be used, and he also briefly explained swaps. After more discussion, they concluded the client’s problem would best be solved through the purchase of a European option from a major international bank such as J.P. Morgan Chase & Co.

Here was a planner who did not rely on his faded knowledge of derivatives to fashion a possibly less-than-optimal solution for a client.

Rather, the planner attended a conference where he could refresh his knowledge of derivatives. When that did not suggest an obvious solution, he sought in-depth advice from a speaker at the conference.

Even though the market has taken back some of the wealth it has provided over the past 20 years, many investors are still in a position to use more-complex investment vehicles, if only for hedging in difficult or uncertain times, and some will demand expertise in them.

More planners will have to become more familiar with puts, calls, swaps and futures. The certified financial planner course provides the basics, but more than an understanding of the basics is needed to advise clients.

I suspect the planners who attended the Risk Management Conference are ahead of the curve.

Mike Clowes is the editorial director of InvestmentNews.

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