Asset managers are among the most important clients for a bank's markets business. They represent the buy side — the ultimate end-users of the securities and derivatives that banks originate and trade. Understanding how different types of asset managers operate, what they need from banks, and what constraints govern their activity is essential for anyone in sales, trading, or structuring.
Long-Only vs Alternative Asset Managers
The asset management industry divides broadly into long-only managers and alternatives:
Long-only managers — including the large index tracking firms (BlackRock, Vanguard, State Street) and active equity and bond managers (Fidelity, Schroders, M&G) — invest in securities on behalf of institutional and retail clients. They are called "long-only" because their mandates typically prohibit short selling. They are benchmark-relative: their performance is measured against an index such as the FTSE All-Share or the Bloomberg Global Aggregate, and their investment decisions are driven by views on overweighting or underweighting individual securities or sectors relative to the benchmark.
Alternative asset managers — hedge funds, multi-asset macro funds, private credit funds, and multi-strategy platforms — have much broader mandates. They can go long and short, use leverage, trade derivatives as primary instruments rather than hedges, and employ complex strategies across multiple asset classes and geographies. Their performance is measured in absolute terms (versus a cash hurdle or on a risk-adjusted basis) rather than relative to a benchmark.
How Asset Managers Use Derivatives
Hedging
Long-only managers use derivatives primarily for risk management. An equity fund manager who is nervous about a near-term market selloff but does not want to sell positions (perhaps due to tax considerations or the difficulty of rebuilding the portfolio) may buy index put options as portfolio insurance. A global bond manager managing currency risk on non-domestic holdings will use FX forwards to hedge the currency exposure back to the fund's base currency.
Overlay Strategies
An overlay is a derivative portfolio managed alongside the underlying physical investment portfolio to adjust the overall risk exposures without changing the physical holdings. Duration overlays — using interest rate swaps to alter the interest rate sensitivity of a bond portfolio — are common in fixed income management. Currency overlays — using FX forwards and options to actively manage the currency composition of a global portfolio — are managed by specialist overlay managers on behalf of pension funds and sovereign wealth funds.
Synthetic Exposure
Derivatives can be used to gain market exposure more efficiently than buying physical securities. A total return swap (TRS) on an equity index allows a fund to gain the economic returns of the index without buying the constituent stocks directly — which may be important for regulatory reasons, cost efficiency, or speed of implementation. In fixed income, credit default swap indices (iTraxx in Europe, CDX in the US) allow managers to gain or hedge broad credit exposure quickly and cheaply compared to building a portfolio of individual corporate bonds.
The Buy-Side Perspective on Pricing and Execution
Asset managers are sophisticated counterparties who understand derivatives pricing well. They will typically request prices from multiple dealers — either via RFQ platforms such as Bloomberg or Tradeweb, or directly by phone for large or complex trades. They will compare prices, negotiate on spreads for large transactions, and assess the quality of each bank's execution and service over time.
From the bank's perspective, asset management clients are valued for the consistency and volume of their flow, their creditworthiness, and the diversity of their product needs (which creates opportunities across sales, trading, and structuring). The largest asset managers command very tight pricing — competition for their business is intense. Smaller managers may receive slightly wider spreads but value service, ideas, and access to balance sheet.
Prime Brokerage Relationships
Hedge funds maintain prime brokerage relationships with one or more banks, through which they access custody, leverage, securities lending, and execution services. The choice of prime broker is strategic — funds typically have two or three prime brokers to avoid concentration risk and to maintain access to different pools of liquidity and financing. Following the collapse of Lehman Brothers in 2008 (which left hedge fund assets trapped in Lehman's London prime brokerage), funds became much more rigorous about counterparty risk and balance sheet segregation.
The prime broker relationship also affects the derivatives trading relationship. A fund that uses a bank as its prime broker will typically route a significant proportion of its cleared derivatives business through that bank's clearing services, generating additional revenue for the prime brokerage division.
Collateral Management
Asset managers using OTC derivatives must manage collateral against their derivative portfolios. For centrally cleared swaps, variation margin is posted daily in cash. For bilateral (uncleared) swaps, the terms of the CSA govern collateral posting. Collateral management has become a significant operational function within asset managers — optimising which assets are posted as collateral (to avoid tying up expensive assets unnecessarily), managing collateral transformation (converting illiquid assets into eligible collateral through repo), and ensuring that the collateral management function does not create liquidity problems at the fund level.
UCITS Constraints
UCITS (Undertakings for Collective Investment in Transferable Securities) funds — the dominant mutual fund structure in Europe — are subject to significant regulatory constraints on their use of derivatives. UCITS funds may only use derivatives for efficient portfolio management (hedging and overlay) or for investment purposes within the fund's stated objectives, subject to risk limits defined by the global exposure calculation (Value-at-Risk or the commitment approach). UCITS funds cannot use unlimited leverage or engage in the kind of speculative derivatives strategies available to hedge funds. These constraints are important context for banks pricing derivatives for UCITS clients: the fund's mandate and UCITS classification may limit the instruments and structures that can be offered.