Like millions of investors, there's a good chance you own mutual funds that you believe are conservative by nature. These could include 澳洲幸运5官方开奖结果体彩网:diversified stock funds and 澳洲幸运5官方开奖结果体彩网:bond funds. However, managers might hold 澳洲幸运5官方开奖结果体彩网:derivatives in your fund's portfolio, and you might not even be aware of it. Why sꦑhould that matter? Well, the good news is that derivatives can boost returns. The not-so-good news is that they also come with increases in risk and tax liabilities.

Three Common Derivatives

澳洲幸运5官方开奖结果体彩网:Institutional investors, such as 澳洲幸运5官方开奖结果体彩网:hedge funds and banks, have used derivatives for years; however, now the following three der𝓡ivatives are🤪 showing up in many stock and bond funds owned by small investors.

Credit Default Swaps

A 澳洲幸运5官方开奖结果体彩网:credit default swap is a type of credit risk insurance against a company or country defau𓃲lting on its debt. Its price is based on the probabilities that the debtor will default on its creditors or eꦰxperience a change in its credit rating.

The swap buyer pays a fee to the seller, and the seller agrees to pay the buyer in case of a default. T♌herefore, a crediꦅt default swap provides the buyer with protection against specific risks. For example, a big corporate bond investor, such as a pension fund, might buy credit default swaps for protection against a default by the issuers of corporate bonds it holds.

Some mutual fund managers, though, have gotten creative in their use of swaps; they have found that swaps can be easier and cheaper to trade than 澳洲幸运5官方开奖结果体彩网:corporate bonds. And by going long or short, it's a simple way to make money or increase or decrease their portfolio's 澳洲幸运5官方开奖结果体彩网:credit risk.

The problem is that swaps are not securities. They are generally agreements between a mutual fund and a Wall Street firm and typically don't trade on an exchange. This means that there is no way for outsiders, such as the 澳洲幸运5官方开奖结果体彩网:Securities and Exchange Commission, to know how much risk any given insti🅷tution has taken on.

Consequently, as the popularity of using 👍swaps increases, the risk goes up that the banks selling the swaps will not be able to meet their obligations if a major def👍ault occurs.

Covered Calls

A 澳洲幸运5官方开奖结果体彩网:covered call, or writing a covered call, is nothing new for investors. You sell a 澳洲幸运5官方开奖结果体彩网:call option on a stock you own. The option gives the buyer the right, but not the obligation, to buy your stock within a set time at a specified 澳洲幸运5官方开奖结果体彩网:strike price. 

There are fund managers who are now getting in on covered calls. They probably see it as a way to boost their fund's income, which can be especially attractive when interest rates are low. Plus, it provides a little downside protection in case of a minor market dip.

But suppose the stock blasts off? The fund would give up all of the stock's profit above the strike price as the call holder 澳洲幸运5官方开奖结果体彩网:exercises the option.

Index Tracking

Is your fund manager's goal to outperform an index, such as the 澳洲幸运5官方开奖结果体彩网:S&P 500? It's possible then, that the manager might invest most of the fund's money in bonds and a small portion in index derivatives, such as options or 澳洲幸运5官方开奖结果体彩网:futures contracts. 

But what if your manager's goal is loftier? 

For instance, some funds seek to outperform daily index returns by a multiple, like two times, or track 澳洲幸运5官方开奖结果体彩网:commodity prices. In such cases, they're most likely using derivatives. And even though small upward mar𓄧ket movements can dramatically increase your fund's value, such a strategy could also backfire during a broad market downturn because index losses will be amplified.

Tax Concerns

Funds that use derivatives frequently trade their holdings. This can mean more 澳洲幸运5官方开奖结果体彩网:short-term gains for shareholders, but you could lose up to 37% of those gains to 澳洲幸运5官方开奖结果体彩网:federal income tax.

Does Your Fund Manager Use Derivatives?

You can go through your fund's 澳洲幸运5官方开奖结果体彩网:prospectus to see whether its manager is allowed to use꧅ derivatives and how they may be useജd. In addition, the quarterly reports should show derivative investments held in the fund.

You can also check out the fund company's website or the SEC's Filings and Forms site. But, make sure you look beyond the percentages. For example, suppose your fund shows that 72% of its assets are in derivatives, but when you look closer, you find that 70% is in 澳洲幸运5官方开奖结果体彩网:U.S. Treasury futures and 2% in credit default swaps. That's a heck of a lot less risky than if those numbers were rever♕sed. 

Shrewd Strategy or Smoke and Mirrors?

Derivatives in a mutual fund can reduce risks and boost returns. However, this strategy generally works best in flat markets,🐼 not markets that are swinging wildly.

Nevertheless, you can expect their use to increase as yield-hungry 澳洲幸运5官方开奖结果体彩网:baby boomers retire and seek higher income from their investments. As of the end of 2019, there were 7,945 mutual funds out there, and managers often think it's not good enough to match a market's index. They want to beat it—and they are willing to bet your money that they can do it, even if it means bypassing the older, simpler products and betting on derivatives.