Derivatives in Mutual Funds

Is the mutual fund industry too dependent on derivatives? It's a little hard to tell, according to a new letter from the SEC, which says that many funds aren't providing adequate disclosure about their uses of derivatives. As a result of this, the SEC thinks that investors may not be fully aware of the risks inherent in their funds.

The action was triggered by several ETFs coming onto the market that the SEC delayed approval for because they dealt heavily in derivatives. While looking into the ETF situation, the SEC also found that mutual funds either described their derivatives holdings in terms that were "generic" or "abbreviated," or else the information wasn't "consistent with the intent" of the required registration forms. In other words, the mutual funds were trying to get around telling investors what the SEC felt investors had the right to know.

The bottom line here is simple: Don't invest in anything you don't understand. If the mutual fund company can't explain what's in their products, don't assume that they understand them, either.