How Asset Managers Use Futures: Equitising Cash, Overlays, Portable Alpha, Duration and the 2022 LDI Lesson

Asset managers use futures to change a portfolio’s market exposure quickly and cheaply without buying or selling the underlying securities. The four main uses are equitising cash (keeping idle cash invested in the market), overlays (shifting asset allocation or hedging currency on top of an existing portfolio), portable alpha (getting index exposure from futures so the cash can be invested elsewhere), and duration management (adjusting interest rate sensitivity with bond futures).

In short: a futures contract delivers the return of an index minus the cost of financing it, while tying up only a margin deposit. That makes it the cheapest way for a large fund to be “in the market” with cash it has not yet invested, or to adjust exposure in minutes rather than days. The trade-off is liquidity: futures losses must be paid in cash every day. The UK pension crisis of September 2022 is the clearest recent example of what happens when a leveraged, futures-like exposure meets a price move larger than the cash set aside for it.

This piece explains how professionals use these tools and where the risks sit. It is not a recommendation to use any of them.

A common misconception: “a fund that uses futures is speculating”

Most asset manager futures positions are not bets. They are substitutes for securities the fund would otherwise hold. A pension fund that receives $60 million of contributions and buys E-mini S&P 500 futures the same afternoon is not adding risk; it is matching the exposure its benchmark already assumes. A bond fund that sells Treasury futures to shorten its duration ahead of a large redemption is reducing risk.

Where futures do add risk is through leverage: buying more exposure than the fund has capital, because the margin deposit is only a fraction of notional value. That is why US regulation of fund derivatives, discussed below, focuses on measuring exposure and value at risk, not on banning futures.

Who the asset managers are in the data

The CFTC’s weekly Traders in Financial Futures (TFF) report splits open interest in financial futures into four reportable groups: dealers, asset managers/institutional (pension funds, endowments, insurers, mutual funds and other managers whose clients are mainly institutional), leveraged funds, and other reportables. How to read it is in the Commitments of Traders report.

Asset managers are structurally long. From the CFTC’s TFF futures-only data:

Contract	Report date	Asset manager long	Asset manager short	Net long	Long as share of open interest
E-mini S&P 500	November 3, 2026	1,111,721	183,137	928,584	56%
E-mini S&P 500	September 27, 2022	903,403	685,284	218,119	40%
10-Year T-Note	November 3, 2026	3,730,323	700,087	3,030,236	63%
10-Year T-Note	September 27, 2022	1,856,635	1,049,054	807,581	49%
2-Year T-Note	November 3, 2026	2,541,571	664,959	1,876,612	57%
Ultra T-Bond	November 3, 2026	1,579,929	704,413	875,516	66%

On the other side, leveraged funds were net short 2,262,310 10-Year Note contracts and 372,318 E-mini contracts on November 3, 2026. The Federal Reserve’s FEDS Note “Quantifying Treasury Cash-Futures Basis Trades” (Glicoes, Iorio, Monin and Petrasek, March 8, 2024) explains the connection: asset managers “may prefer both the higher liquidity as well as the implied leverage of futures positions,” their demand can push futures above cash bonds, and hedge funds take the other side by buying the bonds and selling the futures. That trade is covered in the Treasury basis trade. The authors also warn that leveraged-fund shorts are an imperfect proxy for basis trading.

Use 1: equitising cash

Why cash is a problem

Every fund holds some cash: new subscriptions not yet invested, dividends received, proceeds of sales awaiting reinvestment, a buffer for redemptions. Against an equity benchmark, cash is a bet that the market will fall. In a rising market it costs performance; that cost is called cash drag.

How futures fix it

The fund buys enough index futures to match the cash, and keeps the cash in Treasury bills or a money fund. The futures provide the index’s price return less the financing cost built into their price, and the T-bills earn that financing back. Together they replicate the index’s total return. The arithmetic behind the futures price is in stock index futures explained.

Worked example

Assumptions, all illustrative:

• A $2 billion equity fund benchmarked to the S&P 500 holds 3% cash, or $60 million.
• S&P 500 index: 6,000. E-mini multiplier: $50, so one contract controls $300,000.
• Holding period: one quarter, 91 days. Cash earns 3.90% (actual/360). Index dividend yield 1.20% (actual/365).
• Futures are bought at fair value: 6,000 + (6,000 x 3.90% x 91/360) - (6,000 x 1.20% x 91/365) = 6,041.20.

Contracts: $60,000,000 / $300,000 = 200 contracts.

	Index up 5% in the quarter	Index down 10% in the quarter
Target: index total return on $60 million	+$3,179,507	-$5,820,493
Futures P&L (convergence to new index level)	+$2,588,007	-$6,411,993
T-bill interest on the $60 million	+$591,500	+$591,500
Equitised result	+$3,179,507	-$5,820,493
Cash drag (or benefit) if left un-equitised	-$2,588,007, about 13 bp of the fund	+$6,411,993, about 32 bp of the fund

With futures priced at fair value, the equitised cash tracks the index exactly. In practice the residual comes from three places: futures bought rich or cheap to fair value (each index point on 200 contracts is $10,000), roll costs when the position is carried into the next contract (see rolling futures contracts), and the difference between the fund’s own cash rate and the rate implied in the futures.

The cash still has to be there. If margin were 6% of notional (an assumption for illustration only; exchanges and clearing firms set and change it), the fund would post about $3.6 million of initial margin, and a 10% one-day fall would require about $6 million of variation margin the same day. Equitisation is only safe when the cash backing the futures is genuinely liquid. Margin mechanics are in how futures margin works.

Use 2: overlays and rebalancing

An overlay is a futures position managed on top of a portfolio, often by a separate specialist manager, to change exposure without disturbing the underlying holdings. Common examples:

• Rebalancing. A pension fund with a 60/40 policy finds equities have drifted to 64% after a rally. Selling 4% of the portfolio in index futures and buying 4% in bond futures restores the policy mix the same day; the physical securities can be sold gradually, or not at all.
• Transitions. When a fund changes managers, futures keep it exposed to the market while securities move between managers.
• Tactical shifts. A committee decision to reduce equity risk can be implemented in minutes with futures rather than over days of selling.
• Currency hedging. Funds with foreign assets use currency futures or forwards to hedge some or all of the currency exposure.

Large switches between a security portfolio and futures are often done through an exchange for related position at a negotiated basis, rather than as two separate trades, under CME Rule 538.

Use 3: portable alpha

Portable alpha separates the decision about market exposure (beta) from the decision about where to look for excess return (alpha). The fund gets its benchmark exposure from futures, which need only margin, and invests most of the cash in a different strategy expected to beat cash, such as a hedge fund portfolio or a credit strategy.

Worked example

A $1 billion pension allocation keeps 10% ($100 million) in cash as a margin and liquidity reserve, buys index futures for the full $1 billion of exposure, and invests the other $900 million in an alpha strategy. Cash earns 3.90%. Over one year:

Index total return	Alpha strategy vs cash	Portfolio return	Vs index	Futures variation margin over the year
+10%	+2%	+11.80%	+180 bp	+$61 million received
+10%	-3%	+7.30%	-270 bp	+$61 million received
-20%	+2%	-18.20%	+180 bp	-$239 million paid
-20%	-3%	-22.70%	-270 bp	-$239 million paid

The return arithmetic is simple: the portfolio earns the index plus 90% of the alpha strategy’s excess over cash. The risk is in the last column. In a 20% market fall, the futures require $239 million of cash against a $100 million reserve. The fund must find $139 million by redeeming from the alpha strategy, at a time when that strategy may be falling too, may have redemption gates, or may be illiquid. Portable alpha programs fail on this liquidity mismatch, not on the return math.

Use 4: duration management with bond futures

Bond managers measure interest rate risk as DV01, the dollar change in value for a one basis point move in yields. A $500 million portfolio with a duration of 6 has a DV01 of about $500 million x 6 x 0.0001 = $300,000.

To extend duration to 7 (DV01 $350,000) without buying long bonds, the manager buys Treasury futures with $50,000 of DV01. If each 10-Year Note contract carried a DV01 of about $85 (an illustrative figure: the real value depends on the cheapest-to-deliver bond and changes daily), the trade is $50,000 / $85 = about 588 contracts, or $58.8 million of face value. The pricing of these contracts is explained in interest rate futures explained.

This is the same tool that sits at the heart of liability-driven investment: using leverage to match long-dated liabilities.

The 2022 UK LDI episode

What LDI is

The Bank of England’s December 2022 Financial Stability Report describes liability-driven investment (LDI) as an approach used by defined benefit (DB) pension schemes to match the interest rate and inflation sensitivity of their assets to their liabilities. It put the amount invested in UK LDI products at over £1 trillion. Large schemes run segregated LDI mandates; smaller ones invest in pooled LDI funds.

LDI funds, the Bank explains, generate leverage “either through repo borrowing or via derivatives,” using gilts as collateral to borrow cash and buy more gilts, or using interest rate swaps in which the fund receives a fixed rate. The economic exposure is the same as a long position in long-dated bond futures, with the same daily collateral calls.

What happened

From the same report:

• There were two daily increases in 30-year gilt yields of more than 35 basis points; the largest daily rise since 2000 before that had been 29 basis points.
• Over four days from September 21, 2022, 30-year gilt yields rose 140 basis points, more than twice the largest move since 2000.
• The falls in gilt prices cut LDI funds’ net asset values, raising their leverage, and triggered collateral and margin calls. Bank staff estimated total margin and collateral calls on LDI funds and pension schemes at more than £70 billion.
• Selling gilts to meet them risked “a vicious spiral of falling prices, collateral calls and further forced gilt sales.”
• LDI funds sold about £23 billion of gilts and DB schemes about £14 billion between September 23 and October 14.

The Bank’s 2023 Quarterly Bulletin case study (“Financial stability buy/sell tools: a gilt market case study”) records that it bought £19.3 billion of gilts between September 28 and October 14, 2022 (£12.1 billion conventional, £7.2 billion index-linked), and sold them back over 12 trading days between November 29, 2022 and January 12, 2023.

Worked example: why a 140bp move broke the buffers

Take a simplified pooled LDI fund like the illustration in the Bank’s report: £200 of long gilts with a duration of 20 (convexity 500 assumed), financed with £100 of investor equity and £100 of repo. Leverage is 2x.

	Before	After yields rise 140 bp
Gilt value	£200.0	£153.8
Repo borrowing	£100.0	£100.0
Equity (net asset value)	£100.0	£53.8
Leverage (assets / equity)	2.00x	2.86x

The fund lost 46% of its equity in four days. To restore 2x leverage it had two choices: get about £23 of new cash from its pension scheme investors to repay repo, or sell about £46 of gilts. Pooled funds had many small investors and slow processes, so many could not raise cash fast enough, and selling gilts in that volume into a falling market would have pushed yields higher still. The Bank’s report notes that “raising additional funds quickly was a particular problem for many pooled LDI funds, given operational lags and the large number of smaller investors.”

The policy response, in the same arithmetic

A fund’s yield buffer is how far yields can rise before its equity is wiped out. For the fund above, that is roughly equity / (assets x duration) = 100 / (200 x 20) = 250 basis points, before convexity.

• In March 2023 the Bank’s Financial Policy Committee recommended that the Pensions Regulator set a minimum resilience standard: LDI funds should withstand a yield shock of “at a minimum, around 250 basis points,” with additional resilience for day-to-day volatility and operational risk, according to the Bank’s staff paper “LDI minimum resilience.”
• The December 2022 report found funds had already rebuilt average buffers “in the region of 300-400 basis points.”

With duration-20 gilts, a 300bp buffer caps leverage at about 1.67x and a 400bp buffer at 1.25x. The fix was less leverage and more cash available within the fund, the same discipline the equitisation and portable alpha examples require.

How US funds are regulated when they use futures

For US mutual funds, ETFs and closed-end funds, SEC Rule 18f-4 (Release IC-34084, adopted October 28, 2020; compliance date August 19, 2022) governs derivatives use. Its main elements:

• A fund must generally keep its portfolio VaR within 200% of the VaR of a designated reference portfolio (the relative VaR test), or within 20% of net assets if no suitable reference portfolio exists (the absolute VaR test). Closed-end funds get higher limits of 250% and 25%.
• Funds must have a written derivatives risk management program, a derivatives risk manager, stress testing and VaR backtesting.
• A limited derivatives user exception applies to funds whose derivatives exposure is no more than 10% of net assets, excluding certain currency and interest rate hedges.

A fund using futures only to equitise cash would typically show little extra VaR, because the futures replace exposure the reference portfolio already has.

What can go wrong

• Liquidity mismatch. Futures losses are cash today. If the backing assets are illiquid, slow to redeem or held by someone else, a hedged or fully funded position can still force sales, as in 2022.
• Leverage creep. Margin is a fraction of notional, so exposure can exceed capital without anyone writing a cheque. Regulators measure exposure and VaR for this reason.
• Basis and roll costs. Futures can trade rich to fair value, especially when asset manager demand is heavy, and each roll repays or charges that gap.
• Tracking error. Index futures track the index, not the fund’s actual holdings; duration hedges assume a cheapest-to-deliver bond that can change.
• Operational lags. The Bank of England found that custodians and pension governance processes slowed recapitalisation in 2022.

The short version

Asset managers use futures as low-cost substitutes for securities: to keep cash invested, rebalance and overlay, separate alpha from beta, and adjust duration. CFTC data show the asset manager group holding large net long positions in equity index and Treasury futures, with hedge funds often on the other side. In our examples, 200 E-mini contracts removed up to 32 basis points of quarterly cash drag on a $2 billion fund, while a portable alpha program faced a $239 million margin need against a $100 million reserve in a 20% fall. The 2022 LDI crisis showed the general rule: futures-style leverage is only as safe as the cash available to meet the next margin call. After a 140bp move in four days, the Bank of England’s response was a minimum 250bp buffer, which means less leverage.

Related: The Treasury Basis Trade · Block Trades and EFRPs · How Futures Margin Works