Derivatives, disliked by billionaire Warren Buffett, is gaining momentum in M'sia

Volume rises: Trading volume in palm oil futures increased 44.6 year-on-year to 2.27 million contracts during the first nine months of 2015.

PETALING JAYA: Legendary billionaire investor Warren Buffett is no fan of it – and he makes no secret of his displeasure towards the complicated world of derivatives by calling them the weapons of mass destruction.

But risky as they may be, and regardless of how one perceives these instruments, it is undeniable that derivatives have enabled many investors to hedge their positions and protect their portfolios in an increasingly volatile and uncertain market environment.

And for Bursa Malaysia Bhd, derivatives have been the saving grace for its income growth amid the decline in trading activity in the domestic equity market.

The stock exchange operator - which offers three categories of derivatives, namely the commodity derivatives such as the crude palm oil futures (FCPO) and gold futures; equity derivatives such as the Kuala Lumpur composite index futures (FKLI); and financial derivatives such as the three-month KL interbank offered rate (Klibor) futures - has benefited from higher trading volumes in the derivatives market in recent quarters.

During the nine months to September 2015, for instance, Bursa Malaysia saw its earnings grow 2% to RM148.01mil from the corresponding period a year earlier, due primarily to growth in its derivatives business. It concedes that this alternative market will continue to underpin its earnings growth over the medium term.

In its filings, Bursa Malaysia pointed out that the local derivatives market had benefited from the increased volatility of the underlying products for FCPO, which is its star contract, and the FKLI.

During the nine months to September this year, Bursa Malaysia registered an increase of 16.7% in the average daily contracts traded for the derivatives market to 57,552 from 49,317 contracts in the corresponding period in 2014, compared with the average daily volume of 50,654 contracts for the whole of last year and 43,315 contracts in 2013.

For industry observers, the growth in the trading volumes in the Malaysian derivatives market is an indication that the country’s capital market is maturing and diversifying beyond equity-capital raising and trading into risk management and hedging.

What’s more, they say, it is a positive sign that the local bourse is able to tap into a new market of investors who are familiar with futures and options – which are riskier instruments compared with conventional equities or stocks.

By products, Bursa Malaysia registered an increase of 12.5% year-on-year (y-o-y) in the trading volume of FCPO to 8.27 million contracts, while volume in the FKLI segment increased 44.6% y-o-y to 2.27 million contracts, during the first nine months of 2015.

“It is not just about whether the market is in a downtrend or uptrend, it is the high volatility in the FBM FKLCI that is driving the volume for FKLI,” a trader says.

“As for the FCPO segment, investors are taking their positions, as it is most likely that they think the crude palm oil prices have bottomed out,” he adds.

Noting the bright prospects for the derivative business, CIMB Research says Bursa Malaysia would likely continue to see its income from the segment exhibiting strong growth in the fourth quarter of 2015, similar to the previous three quarters of the year, even as the latter’s equity income would likely remain subdued by slower trading volume.

Meanwhile, derivatives traders say they expect the FCPO to trade range-bound between RM2,150 and RM2,450 until the end of the year.

“There are two sides of the story – there are some bullish elements such as the weak ringgit to support the market, but on the other hand, there are bearish fundamentals that could weigh on the market,” CIMB Bank derivative trader Oo Man Hoong says.