Vanguard's McNabb: Curb on derivatives could smack shareholders

Fund executives are worried that the Securities and Exchange Commission will ban or severely limit how they use derivatives in their portfolios, a decision that they say would have negative consequences for shareholders. F. William McNabb II, president and chief executive officer at The Vanguard Group Inc., said regulators need to understand that derivatives are a crucial part of how many funds operate. “If the SEC were to say ‘no derivatives,' at an extreme it would disrupt the management of funds and hurt shareholders,” Mr. McNabb said today in an interview at the Investment Company Institute conference in Washington. Low-cost index funds, such as those offered by Vanguard, use derivatives to be able to fund redemptions to investors, he said. “Now that's an extreme example, but it shows how important derivatives can be.” The real question that regulators need to ask, Mr. McNabb said, is about what kinds of leverage funds are using. Employing derivatives doesn't mean that funds are using leverage, he noted. “The missing part of this dialogue is leverage,” he said. “We don't run leveraged funds, but every index fund manager uses futures when valuing funds.” Many fund companies, such as State Street Global Advisors, are reaching out to SEC officials to make sure the regulators understand the importance of synthetic instruments to the companies' operations. SSgA uses derivatives to get exposure to certain markets, but not to make leveraged plays, said James Ross, senior managing director of SSgA and president of SSgA Funds Management Inc. “We want to help educate regulators on how we are using derivatives,” Mr. Ross said. Many industry officials are worried that regulators will sweep all derivatives into one bucket, rather than parceling them out and understanding how the yare different. “Asking about derivatives in general is like asking about insurance,” said Barry Benjamin, leader of the investment management and real estate group at PricewaterhouseCoopers LLP “Let's be specific about what we are talking about and which derivatives we think work and which don't.”.