Yes. Derivatives are central to many SIF strategies
Specialized Investment Funds can use derivatives within SEBI’s regulatory framework for purposes including hedging, portfolio rebalancing and permitted long-short positioning.
The SIF framework allows up to 25% unhedged short exposure through derivatives, subject to applicable position and exposure limits. That flexibility is one of the clearest differences between SIFs and many conventional long-only mutual fund strategies.
But derivatives do not automatically make a fund aggressive, and the presence of a hedge does not automatically make it safe. The effect depends on what is being hedged, the size of the position, the derivative used and the market environment.
What derivatives change inside an SIF
A derivative, in plain English. A derivative is a financial contract whose value is linked to another asset or reference, such as a share, equity index, bond yield, interest rate or commodity.
Common exchange-traded derivatives include futures and options.
A fund can use them to:
- reduce an existing risk;
- adjust exposure efficiently;
- express a view that an asset will decline;
- manage duration or interest-rate exposure;
- build relative-value positions.
The same instrument can be conservative in one context and aggressive in another.
A put option purchased to protect an equity portfolio is different from a large unhedged speculative position.
What “long-short” means. A long position benefits when an asset rises.
A short position benefits when the reference asset falls, subject to the mechanics of the derivative used.
A long-short SIF can therefore hold securities expected to outperform while taking short derivative exposure against securities, sectors or indices expected to underperform or to reduce overall market exposure.
The objective is not necessarily to eliminate market risk. It may be to improve risk-adjusted returns, generate alpha from both positive and negative views or manage portfolio beta.
A simple numerical example. Assume a strategy has ₹100 crore in long equity exposure and ₹20 crore of unhedged short derivative exposure.
A simplified way to think about directional exposure is that the short book can offset some long market exposure. But real portfolio risk is more complex because:
- the long and short positions may be in different securities;
- correlations change;
- derivatives have their own pricing dynamics;
- options are non-linear;
- gross and net exposure are not the same;
- hedge effectiveness can change quickly.
Do not reduce a long-short fund to one “net exposure” number without understanding the underlying positions.
Hedging is not the same as shorting for profit
This distinction matters.
Hedging A hedge is intended to reduce an existing risk.
For example, a fund may own a basket of equities and short an index future to reduce broad market exposure temporarily.
If markets fall, the short index position may gain and offset some decline in the stock portfolio.
Unhedged short exposure A manager may also take a short position as an active return-seeking view.
For example, the manager believes a stock is significantly overvalued and shorts it through a permitted derivative position.
If the stock falls, the short can generate a gain. If it rises, the position loses money.
SEBI’s SIF framework specifically provides for limited unhedged short exposure, which is why investors need to understand whether the derivative book is defensive, alpha-seeking or both.
Why a fund may use futures. Futures can provide a relatively efficient way to change exposure without immediately trading every underlying security.
A manager may use futures to:
- hedge broad market risk;
- reduce sector exposure;
- implement a short view;
- rebalance quickly during large cash flows;
- manage interest-rate exposure in debt strategies where permitted.
Futures also create daily mark-to-market effects and require disciplined risk management.
Why a fund may use options. Options can create asymmetric payoffs.
A purchased put can provide downside protection below a certain level while allowing upside in the underlying portfolio. But the option premium costs money, and repeated protection can reduce returns if the feared event does not occur.
Options can also be combined in more complex structures. The investor does not need to master every structure, but should understand whether the strategy’s option use creates capped upside, tail protection, income or additional directional risk.
Protection is not free. Investors often like the phrase “downside protection” but ignore its price.
Insurance is not free.
If a strategy repeatedly buys options to protect the portfolio, premiums can create performance drag during calm or rising markets.
If it uses shorts to reduce market exposure, it may lag strongly rising markets.
This is not necessarily a failure. It may be the expected cost of the strategy’s risk profile.
The correct question is whether the investor values that trade-off.
Basis risk. Suppose a fund owns a portfolio of mid-cap shares but hedges with a broad large-cap index future.
During a stress period, mid-caps may fall much more than the large-cap index. The hedge gains, but not enough to offset the portfolio decline.
That gap is one form of basis risk.
The hedge did not “fail” mechanically. It was simply an imperfect match.
Investors should be sceptical of any claim that derivatives remove market risk completely.
Short squeezes and sudden reversals. Short positions can be particularly painful when a security rises sharply.
A crowded short can reverse quickly on unexpected news, earnings, policy changes or liquidity events.
Even where a fund’s derivative exposure is limited, rapid moves can create losses and force risk-management action.
This is why position sizing and stop/risk disciplines matter as much as the initial investment thesis.
Derivatives are not only an equity story. SIFs are not only about equity shorts.
Debt-oriented strategies can use permitted derivatives to manage or express views on interest rates and other fixed-income risks.
A bond portfolio is sensitive to changes in yields. Longer-duration bonds generally move more when interest rates change. Derivatives can be used to modify duration or implement rate views more efficiently than buying and selling large physical bond positions.
Again, the technique adds flexibility, not certainty.
What SEBI requires investors to be told
SEBI’s SIF framework requires offer documents to disclose material information around derivatives, including:
- scenario analysis for derivative positions;
- maximum derivative limits for exposures beyond hedging and rebalancing;
- strategy-specific risk information;
- redemption/subscription terms;
- other information needed for informed decisions.
That is a strong clue about how investors should behave: do not skip the derivative section because it looks technical.
If the scenario analysis is unclear, ask for an explanation before investing.
A practical way to read derivative disclosures
You can simplify the document into five questions.
- What is the maximum short exposure? Know the regulatory and strategy-specific limits.
- What is the normal expected range? A maximum of 25% does not mean the fund will always maintain 25%.
- Is the short book mainly hedging or alpha-seeking? This changes how you should interpret performance.
- Which instruments are used? Index futures, stock futures and options can behave differently.
- What happens in a sharp rally and a sharp fall? A useful manager should be able to describe both scenarios without promising a result.
Can derivatives make an SIF less volatile?
Yes, they can contribute to lower directional exposure or downside control.
But the answer is strategy-specific.
A hedged hybrid SIF may be designed to produce a smoother return path than a full-equity portfolio. An equity ex-top-100 long-short strategy may still be highly volatile because the long book itself is exposed to smaller companies.
Always evaluate the whole portfolio rather than the derivative label.
Can derivatives make an SIF more risky?
Yes.
Risk can increase if derivatives create wrong-way exposure, concentration, non-linear losses or implementation problems. Even when regulatory limits prevent unrestricted leverage, derivatives can still materially change how the strategy behaves.
This is why current SEBI-filed documents for some equity long-short strategies show the highest Risk Band level.
What investors should ask before investing
When researching how specialised investment funds work, ask:
- What percentage of the strategy is normally short?
- How much is true hedge versus active short exposure?
- What is the largest loss the derivative book has produced in live operation?
- Does the manager use single-stock or index shorts?
- Are options primarily bought or sold?
- What risk limits apply per position?
- How is liquidity monitored?
- How often is the hedge adjusted?
- What benchmark reflects the strategy’s actual exposure?
The distributor should understand derivatives too
Current NISM rules matter here.
From July 2026, NISM-Series-V-D became the specified certification examination for persons engaged in selling and distributing mutual fund and SIF products. Its curriculum includes equity derivatives, futures and options, fixed-income securities, interest-rate derivatives, hedging, trading and arbitrage strategies.
That makes sense. A person distributing a long-short product should understand the tools that create the product’s return and risk.
Through MoneyAnna or any other channel, investors should still ask questions rather than assume certification replaces due diligence.
What matters more than the derivative label
Derivatives are one of the reasons SIFs can do things conventional long-only funds cannot. They can hedge, rebalance and express negative views. Those capabilities may improve portfolio construction, but they also create new sources of risk.
The investor’s job is not to fear derivatives or admire them. It is to understand what they are doing inside the strategy.
Net exposure is not a maximum-loss number
Suppose a strategy has ₹100 of long exposure and ₹20 of unhedged short exposure. It may be tempting to think the portfolio is simply “80% exposed”. That shorthand is incomplete.
If the long book falls while the shorted securities rise, both sides can lose at the same time. Gross positioning, security selection, derivative pricing and liquidity all matter. A 20% short book does not cap the portfolio’s loss at 20%, nor does it guarantee that a market fall will be cushioned by exactly 20%.
| What an investor hears | What it does not automatically mean |
| “The fund can short” | The fund is market-neutral |
| “Short exposure is 20%” | Maximum loss is 20% |
| “Derivatives are used for hedging” | Every derivative position will reduce volatility in every market condition |
| Protection is free or complete |
This distinction is worth understanding before looking at any return chart.
Sources used for factual verification: Securities and Exchange Board of India SIF Regulatory Framework dated 27 February 2025; SEBI Master Circular for Mutual Funds updated in 2026; current SEBI-filed SIF strategy documents; National Institute of Securities Markets NISM-Series-V-D curriculum.
Important: Educational information only. Derivative-linked investment strategies can result in significant losses and should be evaluated in the context of the investor’s overall portfolio.
