Financial futures and total return swaps are synthetic instruments that pension plans commonly use to overlay cash, hedge exposures, and facilitate asset allocation shifts. While the instruments may have similar underlying exposures, there are important differences between the two. For an investor seeking to determine which synthetic instrument is most appropriate in a given situation, careful examination of the following factors will usually yield the most relevant information: tracking error, flexibility, counterparty risks, cash requirements, documentation, financial and trading costs.

This Strategy Spotlight outlines the important factors for investors to consider as they assess the suitability of futures versus total return swaps.