Consider a high-net-worth investor who has recently allocated a portion of their corpus toward a strategy involving index futures to hedge a large equity portfolio. A few weeks later, this client calls you in a panic, observing that their ledger balance has fluctuated despite no actual sale of their underlying stock holdings. They are confused why their account balance is being adjusted daily, fearing that the broker is deducting fees without authorization.
As their distributor, you must explain that this is not a hidden charge, but the mechanism of mark-to-market (MTM) settlement.
In the Indian derivatives ecosystem, MTM is the process where the exchange re-evaluates the value of a futures contract at the end of every trading session. The gain or loss is calculated based on the difference between the daily closing price and the previous day’s closing price or the entry price. If the market moves against the client’s position, the loss is debited from their margin account; conversely, a favorable move results in an immediate credit.
This ensures that the counterparty risk is kept at a bare minimum by settling the obligations daily rather than at the contract’s expiry.
For a distributor, understanding MTM is critical when discussing suitability, particularly for investors transitioning from mutual funds to derivatives-based hedging strategies. Unlike a mutual fund where NAV updates are relatively stable and independent of margin calls, futures require the client to maintain adequate liquidity in their bank account to meet potential margin top-ups.
If you fail to communicate that MTM can lead to sudden cash outflows, the client may be forced to square off a hedge prematurely during a market correction. This defeats the entire purpose of the strategy and can cause unnecessary losses that jeopardize their long-term financial goals.
When assisting a client with an investment strategy—even for SIFs that utilize derivatives—always emphasize that volatility in the futures segment has a direct, immediate impact on available cash. Ensure the investor understands that their capital commitment is not just the initial margin, but also the potential for ongoing MTM debits. By setting these expectations early, you move beyond mere product placement and provide the professional guidance necessary to navigate modern market instruments safely.
Nuance
Check Your Understanding
An investor holds a long position in Nifty futures. At the end of the trading day, the settlement price is lower than the previous day’s settlement price. What is the immediate consequence for the investor?
Why is the concept of Mark-to-Market settlement vital for an investor’s liquidity planning when using index futures?
This is a companion read for Section 15.9 — Uses of futures from Pass Certification Examination for Mutual Fund - Specialized Investment Fund Distributors by Akhilesh Gururani, available on Amazon Kindle.
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