A growing portion of North American institutional investors are using listed and highly liquid equity derivatives for hedging and investing purposes, according to new research from Greenwich Associates.

Institutions are employing these derivatives as an alternative to “cash” equities in gaining exposure or taking positions, and as a means of minimizing equity trading costs, the firm suggests.

The study reveals that a sizable number of North American institutions experimented with equity derivative “flow” products including single-stock listed/vanilla OTC options, listed/vanilla OTC index options, index futures, exchange traded funds, single-stock futures and equity swaps for the first time this year. However, the research also shows a considerable year-to-year fall-off in the use of structured products such as customized OTC, securitized, and hybrid derivatives.

“Our research provides some invaluable insights into how institutions are employing equity derivatives — or in some cases ceasing to use them — in order to get exposure more efficiently, more anonymously, with better tax advantage and greater leverage,” says Greenwich Associates consultant Jay Bennett.

An increasing number of institutions are employing equity derivatives to implement a wide variety of investment strategies, Greenwich reports. For example, the proportion of institutions using single-stock listed/vanilla OTC options has risen from 68% in 2003 to 76% in 2005. Over the same period, the share of institutional investors using listed/vanilla OTC index options has risen from 59% to 63%, and the proportion using index futures rose from 55% to 58%. Exchange-traded funds, which were used by only 57% of institutions in 2003, are now used by two-thirds.

“The rising employment of equity derivatives in such strategies as actively managed long-only equity, passive equity index, and simple price speculation, suggests that a rising number of institutions are using equity derivative instruments as substitutes for ‘cash’ equity trading,” says Greenwich Associates consultant John Colon.

At the same time, Greenwich finds that the use of customized, structured, and hybrid derivative products is declining sharply. In 2004, 50% of investors were using structured products. This year, that’s down to 30%.