How should the use of derivatives by mutual funds be regulated?
Mutual funds could make mistakes in the securities that they invest in, they could make mistakes in the way they interact with their investors, etc. Mistakes in derivatives trading is just one more kind of mistake that they can make. Given free entry into the mutual fund industry, funds which are unable to cope with such complexity will go bankrupt, and funds which are good at figuring out this world will succeed. There is no role for some agency to protect mutual funds from making mistakes. There is, however, a useful role for disclosure. Mutual funds should clearly show investors (in the prospectus) their planned policies about how they would use derivatives. This will enable investors to use the fund with knowledge. An analogy here would be that a car manufacturer should be supplying complete information to the potential buyer of the car of the internal details of how the car would work.
