SRP Thematic/Decrement indices report

Thematic / Decrement Indices

Introduction

In the third chapter of the latest iteration of the SRP Index report we look at the use of thematic indices in the structured products market. Thematic indices remain a focus for innovation as product providers and investors as they provide exposure to the performance of companies associated with particular structural themes, trends and concepts.

Thematic indices are developed to gain access to growth stories shaping the future of economies and societies and have established themselves in the structured products market on the back of increasing issuance and sales.

In this chapter we also look at the use of decrement overlays in indices sold in the structured products market.

This overlay has become an effective feature of underlyings used in structured products by banks as they remove most of the dividend risk and offer higher coupons to investors.

However, there are issues around the use of decrement that must be addressed by product providers such as the level of the decrement, the use of fixed points decrements versus percentage decrements and the risk management of the issuance of decrement products as for manufacturers the spread in volatilities (due the difference of composition) between the decrement index and the liquid index adds dividend risk due to the volatility skew of the liquid index.

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Thematic indices

Thematic indices provide exposure to broad investment themes evolving around the adoption of forward-looking structural changes that are expected to transform social and economic affairs.

Quite often these indices track constituents based in emerging markets or companies in sectors undergoing dramatic overhaul due to the emergence of innovative technologies such as AI or cybersecurity.

The index construction of thematic indices overlaps with other types of indices such as factor-based although thematic indices tend to draw eligible constituents from wider indicesusually constructed by the same index provider - and rank the companies based on historical volatility and dividend yield, as those companies scoring less on the former criteria and more on the latter tend to be favoured.

Within SRP’s index classification the thematic index sector is comprised by several sub-sectors including demographics, founders, emerging markets, luxury goods and megatrends such as cybersecurity, robotics, efficient energy, social trends, demographics, faith-based indices.

The thematic index sector comprises 187 thematic indices used between 1 Jan 2019 and 31 Dec 2022 in the global structured products market.

Some US$2.7 billion was collected from 475 structured products linked to a thematic index in 2022, slightly down from the previous year when US$2.8 billion was gathered from 500 products.

However, sales volumes were up 57% and 35%, respectively, compared to 2020 and 2019. Demand for thematic indices has always been the highest in Europe, Middle East & Africa

In this chapter we focus on thematic indices, which track megatrends and concepts that are likely to shape the future of economies and societies in the decades to come.

Americas: main thematics - market share by sales volume (US$m)

Asia Pacific: main thematics - market share by sales volume (US$m)

(Emea) with interest from investors in the Americas and in Asia Pacific only marginal.

Emea’s market share peaked at 91% in 2022 and has never been lower than 83% in the period 2019-2021. The market share for Americas and Asia Pacific in 2022 stood at five percent and four percent, respectively. In Emea, Italy has become the main market for thematic indices, with volumes increasing from US$20m in 2019 to more than US$1 billion in 2022.

Another market with sufficient demand was France where sales reached US$900m in 2022. In Belgium on the other hand, where approximately US$800m was invested in products on thematic indices during both 2019 and 2020, sales dropped to US$100m in 2022, partly driven by new recommendations on the use of proprietary indices from the Financial Services and Markets Authority (FSMA).

According to the Belgian regulator, custom-made indices, which are often related to one or more investment themes and are determined by algorithms with complex mathematical calculations based on volatility and dividends, significantly increase the risk that investors not (fully) understand these structures.

Emea: main thematics - market share by sales volume (US$m)

In the Americas, the main market for thematic indices was the US, although there too a sharp decline in sales was noticed: from US$325m in 2021 to US$75m in 2022. Volumes in Canada stood at US$35m in 2022 while in Brazil US$30m was invested. Hong Kong SAR was the main market for thematics in Apac, selling around US$150m in 2022, with South Korea and Taiwan, despite no sales in 2022, the only other markets in the region where there was some appetite from investors.

Thematic indices can be divided in three types: price indices, decrement indices and risk-control indices. The former was the dominant type in 2019, but since then its market share has rapidly declined, mostly due to the increased demand for decrement indices. The market share for risk control indices has remained stable.

In 2022, 78% of all volumes came from products linked to thematic indices with a decrement feature (2021: 58%); 20% came from products on price indices (37.5%); and the remaining two percent was tied in products on risk-control indices (4.5%).

In the Americas, US Tech, represented mostly by the MerQube US Tech+ Vol Advantage Index (US$75m from 246 products), was the main thematic in 2022.

Thematic indices: index providers - market share by sales volume (US$m)

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Another theme that grasped the attention of investors was innovative technologies, with Solactive XP Indice de Acoes Americanas de Tecnologia VT 19% the preferred option for investors in Brazil while their US counterparts opted for the Technology Select Sector Index.

Infrastructure (Solactive US Select Infrastructure AR index) was also a theme, but only in 2022, while there was also a smattering of products linked to AI & Robotics (Motif Capital Artificial Intelligence 8 ER Index) and healthcare and wellbeing (Solactive BBVA Health & Wellness SIC MXN Hedged Risk Control 10% Index).

In Apac, only three thematics were seen in 2019-2022: Hang Seng Tech, innovative technologies, and luxury goods. Of these, Hang Seng Tech, courtesy of the Hang Seng Tech Index, achieved the highest volumes (US$185m) in the period.

Sales volumes for innovative technologies, at US$65m, were mainly linked to the Morningstar Exponential Technologies ESG Screened Target Volatility 7% Index, while those for luxury goods (US$25m) came solely from structures on the Solactive Luxury Dynamic Factors 10% Daily Risk Control TR Index.

Of the three regions, Emea was the most diverse, with 27 different themes used in 2022 alone.

Looking at 2019-2022, it is noticeable that every year has a new main thematic. In 2022, healthcare was number one, mostly due to high volumes invested in three products linked to the Euro iStoxx 50 Future Healthcare Tilted NR Decrement 5% EUR Index, which collected a combined US$410m from investors in Italy.

Thematic indices: top 10 by market share 2019 - 2022

Luxury goods and healthcare & wellbeing were the thematics that saw the highest year-on-year (YoY) growth in 2022, registering a 7.6-fold increase and 5.4-fold increase in market share, respectively, according to SRP data.

Innovative technologies were the main theme in 2021, with estimated sales of US$450m, a third of which came from products tied to the Nasdaq Yewno Global Innovative Tech Ex Idx EUR ER 5% Index that were sold in four different markets, including France (12) and Belgium (two).

In 2020, it was mostly pharmaceuticals (US$240m), with the biggest volume, at US$130m, invested in a capital protected structure on the Solactive US Pharma 10% Risk Control 3% Decrement Net EUR Index that was issued by Intesa Sanpaolo in Italy, while another Solactive index, the Europe & US Top Pharmaceuticals 2020 AR 5% Index also caught the eye (US$100m from 25 products sold in seven different markets).

Demography and the ageing population was the most popular theme in 2019 with sales totalling US$620m. The bulk of those volumes (US$545m) came from 14 products linked to the iStoxx Europe Demography 50 index that were issued by Belfius in Belgium. They included Belfius Invest Accelerator 03-2027, an eight-year life wrapped structure that offers 200% participation in the upside performance of the index, capped at 32%. The product sold US$165m at inception. Ten different index providers were active in 2019-2022. Of these, Qontigo achieved the highest volumes, although its market share did shrink noticeable during the period.

In 2022, some US$800m was invested in products linked to Qontigo’s thematic indices – the equivalent of a 30% share of the market. Solactive, which had claimed a market share of more than 50% in 2020, captured 22.5% of the market in 2022, with MSCI achieving a 16% share.

Bloomberg made its first appearance in the thematic sphere in 2022, selling an estimated US$290m from 64 products issued in France (54), Italy (six), Finland (three) and Sweden (one). Most of its sales came from products linked to the Bloomberg Luxury 2021 Decrement 50 Point EUR Index (US$205m from 44 products) and the Bloomberg Inflation European Equity Winners 2022 Decrement 5% EUR Index (US$50m from five products).

S&P Dow Jones Indices held a 2.8% market share in 2022, just ahead of MerQube with 2.7%. During the period under review (2019-2022), US$6.6 billion (or US$3.3 billion each) was invested in structured products linked to thematic indices from Solactive and Qontigo, with both companies having a market share of 36% each.

MSCI, which achieved sales of US$565m (from 99 products) followed at some distance, as did S&P Dow Jones (US$367m from 35 products), Bloomberg (US$290m from 62 products) and Nasdaq (US$285m from 151 products).

At US$797.7m, products linked to the iStoxx Europe Demography 50 Index achieved the highest sales volumes during 2019-2022. The index was exclusively used by Belfius as the underlying for 23 products issued in the Belgian market between January 2019 and December 2021.

The Stoxx Global Technology Select 30 Index (US$576m from 28 products) was available via five different issuer groups, but mainly via J.P. Morgan (13 products) and HSBC Bank (12). The index last appeared on the SRP database in June 2020 as the underlying for an Express Certificate issued in Italy via Société Générale.

Solactive’s Europe & US Top Pharmaceuticals 2020 AR 5% Index gathered sales of US$512m from 108 products that were available in nine different European markets, with the highest sales coming from France (US$250m from 40 products), Finland (US$140m from 45 products) and Italy (US$75m from four products). Some 87% of all products on the index was issued on the paper of BNP Paribas.

Far less products were linked to the Euro iStoxx 50 Future Healthcare Tilted NR Decrement 5% EUR Index (three) and Euro iStoxx 50 Artificial Intelligence Tilted NR Decrement 5% Index (four), but their combined sales still reached a respectable US$411m and US$339m, respectively. Intesa Sanpaolo was the issuing company for products on both indices which were available to retail investors in Italy.

Products on the MSCI World Health Care Select ESG Top 50 5% Decrement Index sold a combined US$325m, with the largest chunk (US$300m) invested in Corralium Santé, an eight-year fund that was issued in June 2022 by Natixis in France. By issuance, MerQube US Tech+ Vol Advantage Index was the most successful. The index, which was licensed to J.P. Morgan, was seen in 366 products (US$222m) that were targeted at investors in the US.

Decrement indices

A decrement overlay is represented as a constant markdown or ‘decrement’ applied to the index. The decrement overlay is constructed by periodically deducting a predefined fee, either in the form of a fixed percentage or index points, from the underlying index.

Decrement indices (single): sales & issuance

Decrement indices (single): sales evolution by region of offering (US$m)

Decrement or synthetic dividend overlays used in indices underlying structured products continue to grow and increase their market share across markets - specially in France - since early 2020 when the dividend crisis triggered by the Covid 19 first lockdown reverberated through the market.

The decrement methodology has been applied to different index strategies – thematic, ESG, single stock underlyings.

The use of decrement overlays where a fixed dividend is periodically deducted from the underlying index has been identified as an area of particular complexity by several regulators including the Belgian FSMA and the Central Bank of Ireland which are calling for enhanced disclosure as the decrement feature can act as a ‘downward drag’ on

Decrement indices (single): market exposure - market share by sales volume (US$m)

performance where it is higher than the actual dividend paid, and in particular where the index falls below its initial level.

Product providers using a fixed dividend deduction in the form of a fixed point value rather than a percentage should be aware that regulators will expect further disclosure as this ‘drag on performance’ will be accelerated if the index falls below its initial level, and that a sustained fall in markets will accelerate the decline in the value of the index if the performance is negative.

The first decrement index seen on SRP’s database was the Euro iStoxx Equal Weight Constant (ECW) 50 Index, which replicates the Eurostoxx 50 Equal Weight Index while assuming a constant dividend of 50 points per year. The index was used

Decrement indices (single): Emea - market exposure

Decrement indices (single): Americas - market exposure

Decrement indices: breakdown per type of synthetic dividend (US$m)

as the underlying for Objectif Février 2015, which was issued by Société Générale in France during February 2015.

Since then, many more products followed with more than 16,300 products linked to a decrement index listed on the SRP database, including some 12,750 that are currently still live.

Single indices

Some US$22.5 billion was invested in structured products linked to a single decrement index in 2022 – down 11% YoY but an increase of 136% and 206%, respectively, compared to 2020 and 2019.

Issuance, at 5,300 products in 2022, remained stable YoY (2021: 5,280) but the increase in issuance compared to 2020 (1,240 products) and 2019 (625) was quite remarkable.

Emea has always been the dominant region for decrement indices. It claimed almost 82% of the market in 2022, up nine percentage points YoY. In the Americas, decrement has also been making inroads, with the region increasing its market share from 0.2% in 2019 to 18% in 2022.

Asia Pacific is the only region where decrement indices remain virtually non-existent.

By exposure, it comes at no surprise that Emea held the largest market share. In 2022, products linked to decrement indices with focus on Emea sold an estimated US$12 billion – the equivalent of a 53% market share. Exposure to Canada was also high (16%) while Transatlantic (US & Europe) and World captured 15% and 14%, respectively.

Emea was dominated by pure Emea indices and Emea indices with a country focus, while Transatlantic and World indices both increased their market share in 2021-22.

The former two had claimed 97% of all sales volumes, and even though their market share has since somewhat declined, by 2022 they still held a respectable 61%. Transatlantic indices sold a combined US$3.3 billion in 2022 (18% market share), including US$700m invested in products on the iEdge ESG Transatlantic Water EW 50 Decrement 5% NTR Index that were issued in France by Natixis.

Indices with exposure to World, which started to gather momentum in 2021 had reached sales of US$3.1billion by

Decrement indices: breakdown of synthetic dividend in points (US$m)

Decrement indices: breakdown of synthetic dividend in percentage (US$m)

Decrement indices: thematic exposure - market share (US$m) Decrement indices: breakdown per value of synthetic dividend (US$m)

2022, mainly on the back of the performance of the MSCI World Climate Change ESG Select 4.5% Decrement EUR Index, which was exclusively licensed to Deka Bank in Germany.

Single stock indices with Emea exposure held 3.8%, up from 1.6% in 2021 when they first appeared. In the Americas, market share for indices with exposure to Canada reached 88% in 2022, driven mostly by several Solactive indices targeted at the country such as the Solactive Canada Bank 40 AR Index and Solactive Canada Insurance AR Index.

Traditionally, products linked to decrement indices that deduct a fixed percentage have always achieved the highest sales: in 2020, their market share was almost 73%. Since then, decrement in points have become increasingly common, which is reflected by a market share of 50% in 2021 and 46% in 2022.

In 2022, some US$12.1 billion was invested in decrement indices that deduct a synthetic dividend in percentage, slightly down from the total for the previous year (2021: US$12.6 billion), but a significant increase compared to 2020 (US$6.9 billion) and 2019 (US$4.8 billion).

Eighty five percent of sales in 2022 came from products linked to indices with a fixed percentage of 5%, the same as in 2021. Indices with a fixed percentage of 3.5% and 4% increased their market share since 2020, while those with a percentage of 3% remained relatively stable.

The use of indices that deducted a fixed 2% has phased out in recent years. Volumes for products linked to indices that deduct synthetic dividend in points were initially quite low, at around US$2.5 billion in both 2019 and 2020. They peaked at

Decrement indices: index providers - market share by sales volume (US$m)

Decrement indices: top 10 by market share 2019 - 2022

US$12.4 billion in 2021 before slightly tailing off the following year (2022: US$9.8 billion).

Indices with a points tally of 50 dominated, especially in 2019 when their market share reached 100%, but they continued to perform well in subsequent years, claiming 62%, 46% and 58%, respectively, of all volumes in this segment. Indices that deduct 30 points and those that abstract more than 50 points have increased their market share since 2020 while those that deduct 40 points made their mark in 2022 when they captured a 22% share. The latter was mostly driven by the popularity of the Solactive Canada Bank 40 AR Index, which collected US2.6 billion in Canada alone that year.

In 2019, ESG and ‘Broad market’ were the main thematic exposures for decrement indices, with a market share of 44% each. Since then, ESG has increased its market share, which was around 56% in 2022, while that of ‘Broad market’ fell to 11% that year.

Another thematic that has been making inroads is the industry sector, which was non-existent in 2019, but was linked to sales of US$6.7 billion in 2021 – the equivalent of a 27% market share.

Sales linked to geography themed decrement indices went from US$800m in 2019 to US$360m in 2022 while single-stock indices, which first came on the scene in 2021, collected US$720m in 2022 (+140%YoY), mostly due to their popularity in the French market.

During the reporting period, Euronext, Qontigo, Solactive, MSCI, and to a lesser extend S&P Dow Jones, have been the main providers for decrement indices, with SGX, Bloomberg and Morningstar the new kids on the block.

Euronext captured 64% of the market in 2019, when its decrement indices were used in 230 products that sold an estimated US$4.7 billion across eight jurisdictions, but mostly in France (207 products). The following years its sales volumes remained roughly the same, with the exception of 2022 (US$3.1 billion), although the company’s market share somewhat decreased due to the increased competition (2022: 14%).

Fifty-seven Euronext decrement indices were used as the underlying for 895 structured products in the period 2019-2022. They included the Euronext Climate Objective 50 Euro EW Decrement 5% Index (US$2.7 billion from 36 products), SBF Top 50 ESG EW Decrement 50 Points (US$2.6 billion from 204 products), and Euronext Euro 50 ESG EW Decrement 50 Points Index (US$1.9 billion from 134 products). The former was used by Natixis only while the other two were exclusively used for products issued via Société Générale.

Qontigo’s market share peaked in 2020 at 24% but the company achieved its highest sales a year later when the 530 products linked to its decrement indices gathered an estimated US$4.9 billion. During 2019-2022, its products were sold across 19 different markets, with France once again

collecting the highest sales (US$10.3 billion), followed by Italy (US$2.6 billion), and, at some distance, Spain (US$115m).

During the period, Qontigo’s flagship decrement indices included the Euro iStoxx Equal Weight Constant 50 (US$2.3 billion from 410 products), which was licensed to Société Générale, and Euro iStoxx 50 Carbon Adaptation GR Decrement 5% Index, which was used by Crédit Agricole in France and by Unicredit in Italy.

Solactive reached its highest market share, at 34%, in 2021 when 2,800 products tied to its decrement indices sold an estimated US$8.6 billion. In 2022, its sales dropped to a still reasonable US$5.1 billion (23% market share).

The German company differs from its competitors in the fact that its focus is very much on the Canadian market, where more than 5,300 products worth an estimated US12.2 billion were linked to its indices between 2019-2022. Solactive’s main indices in Canada were the Solactive Canada Bank 30 AR and Solactive Canada Bank 40 AR indices, with combined sales of just under US$5 billion, as well as the Solactive Canada Insurance AR Index (US$1.9 billion).

In France, its second market behind Canada, the Solactive France 40 Equal Weight NTR 5% AR Index (US$675m) and Solactive Transatlantique 5% AR Index (US$285m) were popular options for investors while in Italy the Solactive US Pharma 10% Risk Control 3% Decrement Net EUR Index accumulated the highest sales (US$130m).

MSCI steadily increased its market share from 3.3% in 2019 to 21% in 2022, when it collected US$4.8 billion from 1,635 products. Its main market, certainly by issuance, was Germany, where it achieved sales of US$5.5 billion from 3,188 products between 2019-2022, although in France, where it sold US$3.4 billion from 110 products, average tickets were much higher.

In Germany, its most popular index was the MSCI World Climate Change ESG Select 4.5% Decrement EUR Index (US$3.7 billion from 1,950 products), which was exclusively licensed to Deka Bank, while there was also demand for MSCI Germany Climate Change ESG Select 4% Index (US$700m) and MSCI EMU Climate Change ESG Select 4% Decrement Index (US$450m).

The MSCI Europe Select Green 50 5% Decrement Index (US$1 billion) and MSCI France Select ESG 30 5% Decrement Net Index (US$715m) were the preferred option for the French investor, while MSCI decrement indices were also seen in Belgium, Italy, Finland, and even China (MSCI World ESG Screened 5% Risk Control Index).

SGX was the calculator and publisher for the iEdge indices, which were licensed to Natixis. They were first seen as the underlying for structured products end-2020 and by 2022 their market share was 6.5%. In total, 106 products worth an estimated US$1.9 billion were linked to the iEdge indices, including 101 that were issued in France, with the remaining five targeted at investors in Finland. At US$975m, halve of the total volumes were invested in nine products linked to the

iEdge ESG Transatlantic Water EW 50 Decrement 5% NTR Index.

Bloomberg decrement indices made their first appearance in January 2022 on the SRP database, and by the end of the year they were used across 144 products worth an estimated US$650m (2.9% market share). Again, France was the main market (US$595m from 136 products), whilst there was also activity in Italy (US$57m) and Finland (US$2.5m). Its most used index was the Bloomberg Luxury 2021 Decrement 50 Point EUR Index, which gathered US$215m from 47 products.

FTSE Russell’s presence was limited to the UK and France. In the UK, the bulk of its volumes came from the FTSE Custom 100 Synthetic 3.5% Fixed Dividend Index (US$115m) and, to a lesser extent, FTSE 100 Equally Weighted 45 Point Decrement Index (US$20m), while the FTSE Transatlantic EW Decrement 50 Points TR Index (US$80m) and FTSE France 40 Low Carbon ESG Screened Decrement 50 Points Index (US$65m) were its main indices in the French market.

Morningstar, which, like Bloomberg, made its first appearance in 2022, saw five of its decrement indices used in 33 products across France, Finland and Sweden. Of these, products linked to the Morningstar DM Europe Large-Mid Oil & Gas Decrement 50 Point Index and Morningstar Eurozone 30 Basic Resources Banks Energy Decrement 50 GR EUR Index were the most popular, selling US$60m and US50m, respectively.

Nasdaq’s decrement indices were limited to Nasdaq Yewno Global Innovative Tech Ex Idx EUR ER 5% Index, which was seen in 27 products sold across six different jurisdictions between June 2020 and September 2022. Additionally, its Nasdaq 100 Total Return 2% Decrement Index was used as part of a basket, together with Russell 2000 2% Decrement Index and S&P 500 3% Decrement TR Index, in five products targeted at investors in the US.

Decrement indices (multi): sales & issuance

Multi indices

Volumes invested in structured products linked to a basket of decrement indices were much lower compared to those of their single index counterparts (2019-2022: US$1.8 billion vs US$64.8 billion). Some US$668m was invested in structured products linked to a decrement basket in 2022 – down 24% YoY but a two-fold and 15-fold increase, respectively, compared to 2020 and 2019.

Issuance, at 323 in 2022, remained stable YoY (2021: 352) but the increase in issuance compared to 2020 (27 products) and 2019 (26) was significant. The Americas was very much the dominant region for products linked to a basket of decrement indices, mainly on the back of their success in the Canadian market, where 672 products collected US$1.4 billion between 2019-2022.

The three most used indices in the period were Solactive Canada Insurance AR Index (441 products), Solactive Canada Pipelines AR Index (417), and Solactive Canada Telecommunications AR Index (255).

In the US there was far less appetite (US$3.8m from seven products), while in Emea, which was the main region for products linked to single decrement indices, they gathered sales of a mere US$125m between 2019-2022.

Here, three MSCI indices were the most used in a basket: MSCI Europe Top ESG Select 4.5% Decrement Index (14 products), MSCI Europe ESG Leaders 5% Decrement Index (13), and MSCI Switzerland ESG Leaders 5% Decrement Index (13).

Sales in Asia Pacific between 2019-2022, at US$385m, came solely from 54 products sold in the Korean market, where S&P 500 KRW Hedged 2% Decrement Index ER, Euro iStoxx 50 KRW Hedged Decrement 3.5% ER, and S&P 500 80-Point Decrement Hedged Index, were among those the most frequently seen.

Decrement indices (multi): sales evolution by region of offering (US$m)

MSCI

Thematic indices create a link between the economy and the investment

Demand for thematic indexes continues to increase and now represents just under half of the client enquires MSCI receives on structured products.

Appetite for megatrends is different depending on the region. Europe is very focused on the environment, and themes like green technology and clean energy are driving the creation of new thematic indexes; whereas the US is more interested in tech and APAC sits in the middle. There is also a convergence on some megatrends like AI which are on demand in the three regions.

“Demand for thematic indexes is very strong,” says Stephane Mattatia, global head of thematic indexes and derivatives licensing at MSCI. “At a product development level, the focus is on finding themes that are part of long-term trends that are going to be relevant for six to ten years – such as green technology and demography – and not as much on short term trends that can be seen as fads, like chatGPT or the Metaverse. In this category, you want the thematic to remain relevant for the long term.”

The second leg of MSCI’s thematic indexes is driven by the global macro-economic environment and comprises indexes that are adapted to the market conditions. In this category, the index provider launched the MSCI global thematic sentiment rotation select index in late 2022 which plays on the increasing demand for thematic exposure and uses the same concept applied to factor and sector rotation strategies.

This index is aimed at investors that don’t want to be exposed only to one theme and prefer to rotate their exposure as economic conditions change,” says Mattatia. “We see a lot of appetite for this kind of strategy. The demand is linked to the return of a global macro-economic environment which was absent for 15 years, - no inflation, zero interest rates, etc. Extracting value of global macro conditions is a necessity and there a number of variables (interest rates, inflation) that you have to factor in as they are going to stay with us for a long time.”

In contrast with other index providers that see ESG as a theme, Mattatia doesn’t consider ESG as theme because everything can be looked at with an ESG lens.

“I don’t think ESG is a factor nor a theme, and it is definitely

not an overlay. ESG is a super structural dimension that runs parallel to market cap,” he says.

Disclosure

Once you have established that a theme is economically sound and would remain relevant for some time, the MSCI research starts with simulations to test the strategy around the number of stocks that have been or can be captured and also applies the Average Relevance Score of the companies that are selected.

“If you go for something which is too granular with less than 10 stocks, quite often the issue is representation. You want to make sure that you have enough companies with high relevance score so that you can really capture the theme, because with some of the trends there is no pure players. If you select 20 stocks with scores no higher than 30% you are not capturing a theme,” Mattatia says.

Under the BMR as a benchmark administrator, MSCI is obliged to take extra precautions with the naming of thematic indexes and ensure they are not misleading, “especially if a theme is difficult to capture and you have to broaden the theme to have enough stocks”.

“You cannot oversell something that is impossible to capture,” Mattatia says.

Product development tools

Over the last few years, the use of different AI tools such as natural language process (NLP) to develop new thematic indexes has increased as they allow index providers to approach product development in a different way.

MSCI partnered with MKTMediaStats, a Boston-based data fintech specialised on media, to apply automatic rotation to thematic exposure using natural language process and select securities based on a specific media sentiment (MKTMediaStats Megatrend Scores).

The MSCI Global Thematic Sentiment Rotation Select Index aims to represent the performance of the four highest ranked

thematic indexes, selected quarterly from a set of twenty-two MSCI thematic indexes including the MSCI ACWI IMI Ageing Society Opportunities Index, MSCI ACWI IMI Autonomous Technology & Industrial Innovation Index, and MSCI ACWI IMI Blockchain Economy Index, among other MSCI ACWI indexes.

According to Mattatia, this allows us to identify which companies are correlated with the strength of the narrative and have a point of view on how the economy is doing and offering clients real time asset, an equity allocation.

“We are working on other projects and trying to identify trends earlier and deliver performance with reduced risk. There is a huge field of activity emerging with artificial intelligence, machine learning and big data,” he says.

The market is very far from using generative AI, but there are modular parts, which have been existing for many years now in artificial intelligence, that can help create new products and identify new themes.

“AI is able to analyse millions of documents at a capacity that no human being can deliver and is allowing us to do things that the human brain could not have been able to do,” Mattatia says. “The processing of data is what makes AI an interesting tool to develop new indexes, but you still need the human element to understand every step of what AI is doing.”

Complexity, Overlays

Thematic indexes are more complex than market cap indexes and index providers must be able to justify and explain the goal of these indices in very simple terms. The use of overlays is not really related to the complexity or the lack of liquidity of thematic indices but with removing market risk and optimising the underlying to be delivered via structured products.

Some of the overlays allow trading desks to be more aggressive with pricing as they reduce accumulation on positions and the exposure an index has to dividend futures, according to Mattatia.

“This became obvious two years ago when issuers of structured products saw their trading books hit by the dividend crash. There we not enough dividend products out there to hedge the dividend exposure of indexes and decrement became the obvious way to remove the accumulation of dividend exposure on trading books,” he says.

Overlays like decrement also allow product providers to improve the optionality of the index and offer better pricing (upside) on the index.

“Having an index with lower forward allows product providers to give back this value to the investor in a structured product

in the form of a higher coupon and / or a lower barrier,” says Mattatia, noting that decrement has become “a very useful tool for issuers to improve the value offered by their products. It is important however that the end investor understand that the decrement will have an impact on the performance of the underlying if it’s trending down”.

On the debate around the use of points v percentage on decrement indexes, MSCI’s preference is for decrement in percentage because the performance is closer to the benchmark, but it delivers both types.

“We have internal rules for the calibration of the level of the decrement to ensure we don’t compromise the quality and objective of the index,” says Mattatia. “Mathematically, you can apply any kind of decrement to an index, but you want to be aligned with what people have in mind.”

Fading interest?

With low interest rates the challenge for product providers was to offer meaningful coupons and upside. Higher interest rates have had a positive impact on option budgets as they allow to offer better upside and more protection. This could have an impact on the demand for indexes with overlays such as decrement. However, market data suggests otherwise. Issuers of structured products like decrement because it reduces the risk in terms of hedging but also allows them to differentiate and compete with other asset classes like fixed income that can now offer coupons of up to five percent, according to Mattatia.

“If you can deliver six to ten percent with an equity index you can fend off some of the competition coming from fixed income recently. I expect decrement will continue to be widely used for these reasons,” he says.

On the use of overlays, MSCI has started to notice some people showing signs of of ‘decrement fatigue’ whilst risk control remains an interesting overlay for structured products going forward as it enables issuers to have a dynamic leverage on the index, and a hedge that can be reinvested in the product for the benefit of the end investor.

“I wouldn’t be surprised if in the coming years we see some new innovation coming to replace or refresh the decrement overlay. I think there is also scope to see more risk control and decrement indexes alongside in the market,” says Mattatia.

Outlook

Thematic indexes are here to stay because they offer a different perspective to investors and create a link between the economy and the investment. With the increase competition coming from fixed income as a result of the rise in interest rates structured products linked to fixed income indices could be an attractive proposition.

STOXX Indices Improved datasets are helping design new investment themes

STOXX is the main provider of thematic indices to the global retail structured products market and is also the supplier of one of the most popular thematic/sector underlyings used in the market - the EURO STOXX Banks index, which has an outstanding volume of US$7.9 billion across 16,735 products.

The index provider is also a top three provider of decrement underlyings: during 2019-2022, its decrement underlyings were deployed across 19 different markets with sales exceeding US$12 billion.

In the last two years, STOXX’s thematic indices have been featured across 203 products worth an estimated US$3.3 billion, which represent a 36% market share in this category. Four of its thematic underlyings dominate the top five ranking: iSTOXX® Europe Demography 50 index, STOXX® Global Technology Select 30 index, EURO iSTOXX® 50 Future Healthcare Tilted NR decrement 5% EUR index and EURO iSTOXX® 50 Artificial Intelligence Tilted NR decrement 5% index.

When it comes to strategies, both the innovation and the trends seen in other segments of the market in the last couple of years have emerged as well in the structured products market, according to Armelle Loeb, STOXX’s head of index sales for emea and member of the company’s management board.

“Investors want to target the same themes and strategies that are capturing the imagination elsewhere, but to do so with the benefits of a structured note,” says Loeb. “That includes growth-oriented technological themes, as well as sustainability objectives. Both areas keep delivering exceptional innovation in terms of ideas and methodologies. Besides that, decrements also continue to see significant uptake as do volatility target indices.”

We sat down with Loeb to ask her about the most recent market developments.

What thematics are resonating with investors at the moment?

One example of those trends is the EURO iSTOXX 50 Future Healthcare Tilted NR Decrement 5% index, which combines a strong technology-related theme with a decrement. In fact, the index was the most popular underlying for

structured products in 2022 in terms of assets under management. The index tracks the benchmark EURO STOXX 50® plus the 10 largest securities from the STOXX® Global Breakthrough Healthcare index, while assuming a constant, annual 5% performance deduction.

Two other thematic indices with strong inflows last year were the EURO iSTOXX 50 Artificial Intelligence Tilted NR Decrement 5% and the EURO iSTOXX® 50 Sharing Economy Tilted NR Decrement 5%.

This year, if anything, has seen even stronger interest in these themes, particularly as the market has embraced the economic potential of AI. I expect new technological themes, such as the Metaverse and future mobility, to gain traction.

What role do ESG considerations play as investors embrace these new thematic strategies?

ESG is at the very center of every conversation with clients. The Sustainable Finance Disclosure Regulation (SFDR) has been a major driving force, and I don’t expect any slowdown there. Quite the opposite, actually.

In the post-pandemic world, all clients want an ESG, climate or – most lately – biodiversity angle for their strategies. Either as a pure play or main objective, or in the form of exclusions attached to a strategy, for example a thematic one.

Biodiversity is emerging like a new paradigm, with new metrics being developed that can help investors measure their impact on ecosystems. We recently launched the ISS STOXX® Biodiversity indices, which exclude companies involved in activities causing harm to biodiversity, select securities that have a positive impact on ecosystems and those enabling exposure to relevant UN Sustainable Development Goals (SDGs), and, finally reduce the portfolio’s carbon emissions. These steps can be used as a core strategy, but we are also discussing with some clients the integration of some of those filters as biodiversity exclusions within a broader strategy.

ESG is at the very centre of every conversation with clients

Armelle Loeb, STOXX

I should not forget to mention climate strategies, where we see a lot of interesting developments every month. That includes Paris-aligned benchmarks, clean energy and even indices tracking energy transition metals. In most of those cases, investors can now make use of measurements to tackle their goals that weren’t available only a few years ago. It is indeed very interesting times for everyone.

Has the shift towards customisation opened the market to new players seeking to deliver tailored underlyings?

What we have seen is the arrival of specialised data companies that provide new and smart datasets. As index provider, we welcome that. A lot of the new investment themes are difficult to build using traditional revenue-based data or sector classifications.

For many of these emerging themes we need something else – for example, patents. With all these new datasets, you can detect trends more quickly with AI tools than you would be able to see via revenues. You can capture forward-looking growth.

At STOXX, we have a flexible open architecture approach that allows us to work with these data providers and be able to offer the right solutions in a more efficient and reactive way. They are bringing extreme innovation in data, so by partnering with them they can enhance the value of our methodologies.

As the number of custom strategies increases, so does the complexity of some of the underlyings. Are there any suitability concerns around some of the thematic indices we see in the market?

Complexity is a broad word. Some strategies are, by definition, complex, like a Paris-aligned benchmark that is required to comply with regulation. An optimization is also complex. We need to be clear on the definition of complex – and it is not an easy one. Innovation is at the core of the STOXX indexing business, and we specifically aim to bring ever-more sophisticated strategies to the market where we

can combine our expertise with smart data or with tools such as Axioma’s portfolio construction capabilities. We have over two dozen thematic indices, for example, with customized versions derived from many of them. The selection process for many of them is no longer based on the more traditional metrics of industry or revenue, but on novel data such as patents, satellite images or companies’ annual reports.

Clients are now much more involved in the design of the indices than they were 20 years ago, and often it is them who lead in the adoption of innovative selection mechanisms. The level of sophistication that they have is very high.

That said, sophistication and customisation are welcome as long as they don’t undermine the transparency and rules-based objectivity of the strategy. Complexity should not and does not equate to higher risk. These days you can optimise your strategies and calibrate your desired risk level to the detail. Better technology empowers investors, and we should make the most of that.

We spend as much time ensuring our strategies are clear, accurate and replicable as we do look for the best methodology tools. Not all indices will be suitable for all clients, and it is the duty of intermediaries to make sure that investors are well aware of where they put their money. That basic premise of retail investing still stands: investors must understand what’s under the hood of the products they buy.

Where do you see the structured-products market in the next couple of years?

I definitely see more innovation coming ahead, whether in themes or in methodologies. We have been through some very challenging times with the pandemic, the global slowdown, rising interest rates and the war in Ukraine. Throughout this time, all these challenges have provided fertile ground for issuers to come up with imaginative strategies – to the benefit of end clients. It is true that difficult macro environments can benefit the industry, but I don’t see why, at the same time, that growth should not continue in more market-friendly times!”

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FTSE Russell Traditional sector classification framework not enough to capture new trends

FTSE Russell entered the thematic segment of the structured products market in 2022 with the FTSE Developed Europe Index which was featured across 12 products sold in France worth an estimated US$66 million, which is testimony to the index provider’s renewed focus in the structured products market.

In the decrement space, FTSE Russell has seen several of its synthetic dividend indices used across 120 products worth an estimated US$300m over the last two years - its presence was limited to the UK and France which registered several of its decrement indices including the FTSE Custom 100 Synthetic 3.5% Fixed Dividend Index; FTSE 100 Equally Weighted 45 Point Decrement Index; FTSE Transatlantic EW Decrement 50 Points TR Index and FTSE France 40 Low Carbon ESG Screened Decrement 50 Points Index.

On the current driver of thematic indices, Norbert Van Veldhuizen, head of equity index product, Emea at FTSE Russell, points at “the megatrends that are changing our society and the world we live in” as well as climate change “although this is more of an investment theme in Europe than in the US”.

Other themes being developed at FTSE Russell from an index perspective include the digital economy, the Internet of Things, connectivity, cybersecurity and the future of transportation.

“People work from home, connect with work in multiple ways and don’t go to the High Street to shop but rather shop online and have goods delivered to their house,” says Van Veldhuizen.

“Online shopping isn’t new but is still a big driver of how we live our lives and is impacting various industries.”

Van Veldhuizen notes that the growth of “the big Amazons” is not only impacting real estate and high street retails but also warehouses and inner cities like London which “are pushing for cleaner air and introducing congestions charges which supports the development of electric cars and delivery vehicles”.

“Those are just a few examples of big trends in society that are recognised more and more by investors as they offer opportunity,” says Van Veldhuizen. “Thematic indices offer a way for retail investors to implement their vision and investment ideas and incorporate them in their investment portfolios. We see more demand from retail investors for thematic indices.”

The problem the market faces, according to Van Veldhuizen, is that not all these trends and themes can be captured in one sector and the traditional sector classification framework alone is not enough.

“Therefore we are using new and more agile techniques to capture the trends that are going beyond the sectors as some themes overlap and theirs is also a crossover around companies and their activities,” he says. “We are using a more flexible approach in addition to the sector classification.”

The transparency of the methodology and the rules-based approach are elements to protect the end investor

Norbert Van Veldhuizen, FTSE Russell

Is the structured products market offering new opportunities when it comes to innovation around thematic investing?

That’s the nature of the structured products market. In the past, ETFs were seen as an efficient vehicle to bring innovation in the form of new exposures, but the structured products market has become over time a catalyst for innovation.

Issuers are more flexible to push out products and be opportunistic. An ETF provider must go through the regulatory issuance process which can be lengthy whereas for structured products the issuance process is easier - we construct the index, and the manufacturer models the derivatives and options around the underlying and wraps it in a product.

Structured products and ETFs target the same kind of audience and they both offer flexibility to access market trends.

Some themes are difficult to classify. Are there any concerns in relation to emerging thematics and adding unnecessary complexity to underlyings?

The transparency of the methodology and the rules-based approach are elements to protect the end investor.

Retail investors are not financial experts and some themes around technology are less transparent in the sense that there is no standard for artificial intelligence, for instance, because some of these trends are emerging at a very quick pace.

There is no sector to classify artificial intelligence, and these are problems coming up on the back of emerging thematics. Standardisation will be key for the indexing industry in general to ensure thematic indices remain a simple building block for retail investor.

What are the criteria FTSE Russell’s uses to define themes that are consistent and relevant for the long haul?

It is important to define themes that are long lasting as opposed to ‘flavour of the month’ type of dynamics as we saw with 3D or wearable technology. Some companies and activities take the spotlight on the back of market developments which are not really trends.

That is why we look at megatrends and trends that are changing and impacting our society and our lives, and not as much at sub sectors and sub themes. Some

themes are related to broader themes that would stand the test of time.

Do you think there is scope to grow the weight of thematic underlyings in the structured products market?

Thematic indices have a place in investors’ portfolios, and they will benefit from technology developments and improved datasets – there is increased demand for better transparent data, which has triggered the development of more specialised datasets - on climate, on carbon intensity, on ESG scores as well as other data points regarding a company’s activities and investments

I think that’s going to be broken down even further and will enable the development of robust strategies based on solid datasets that can capitalise on new techniques to get information and incorporate data points to indices beyond company reports and filings.

New techniques based on artificial intelligence (AI) and machine learning are allowing us to get information out of unstructured data and make it structured so that we can process it to build a product. Those two elements are crucial not just for the development of thematic indices but for any strategy or emerging theme.

What is your opinion on the use of overlays in thematic indices?

Overlays are a great tool for product manufacturers to manipulate the risk-return profile of an index to build attractive structured products and offer returns that are attractive to their audience.

We believe overlays offer a good way to structure products and tailor them to meet the needs of their clients in a certain market cycle. In a more risk-off and volatile environment, there’s will be more demand for defensive risk control type of overlays whereas in a different market environment there might be more appetite for risk and risk taking in which case leverage overlays can be used to implement a market conviction.

That’s a great way for investors to benefit and to protect themselves and use structured products to their full potential. As an index provider, of course, the transparency of every strategy is pivotal and regardless of the type of overlay (risk control, decrement, leverage) it should be very clear and available on the product prospectus and marketing documents.

MerQube Thematic indices can achieve more precision as a building block

MerQube is one of the latest entrants to the structured products market and managed to place its MerQube’s US Tech+ Vol Advantage Index as one of the highest selling thematic indices in the US market –the index was used in 246 products issued via J.P. Morgan in the US worth US$74mn in 2022.

The MerQube’s US Tech+ Vol Advantage Index which is licensed on an exclusive basis to J.P Morgan, which also has a stake in the index provider, was featured across 366 products (US$222m) sold in the US.

MerQube’s identity as an index provider is very much geared towards scaling technology and looks at thematics as a very broad area where a lot of things can be included.

“When we develop an index, we typically work with a third-party provider to get the data sets behind it, and then design the strategy,” says Vinit Srivastava, CEO at MerQube.

“Then there are additional layers - decrement, risk controlwhich is just a means to make the structure more efficient, whether it’s AI or ESG related. The evolution of indexing is happening, and there is a need to get more data and bigger data sets quickly.”

Thematics represent the natural progression of the evolution of indexing and allows investors to gain access to much more specific themes and even single stocks to achieve a specific goal, according to Roby Muntoni as chief commercial officer.

“Back in the days, investment opportunities were restricted to a few indices or a few asset classes. Now indices have become almost like another tool to get into a bigger strategy or get additional precision in your exposure to a theme,” she says, noting that indexing as a whole has become mainstream as not just the strategy but potentially as a building block that drives efficiency in pricing.

“Thematic indices is a reflection of that evolution driven by people demand which is getting more and more precise,” says Muntoni.

“We can see how different themes are evolving and how investors want specific exposure to certain themes - ESG has become the front and centre for many investors,

and you can see a bifurcation and the development of new sub-themes like carbon efficiency, Paris-aligned and socially responsible investing (SRI), etc.”

According to Srivastava, thematics are getting more and more precise while the classification of themes is being driven by all kinds of company data, “and the realisation that new and alternative datasets can be used to have a better view of the same set of stocks, like how stocks behave as a group”.

“The development of thematic indices mirrors the evolving economy and landscape – and the expansion of the investment toolkit,” he says. “Thematics is not just a very precise tool but it’s also very flexible as it allows you to develop new strategies based on old concepts such as rotation.”

Putting a label is the easiest way to explain what you’re trying to achieve and ensure that it resonates with the end investor, according to Muntoni.

“But if you look under the hood at the end of the day, what we do as an index provider is to allow people to invest in what they believe and what they think,” says Muntoni.

“Thematic strategies make sense as long as the components in an index offer an efficient way to gain exposure to a specific growth story – either they are tracking a stock or` have a specific pointed goal, as long as that becomes efficient. To some extent, the index is just yet another vehicle to facilitate access and exposure.”

Thematic indices can achieve more precision as a building block which explains the tremendous increase in the use of thematic indices and other strategies in structured products.

“The passive investment market continues to evolve and overcome some of the limitations of the active management approach - to some extent some of these

tactical strategies were only available through active managers because the portfolio manager knew how to use the standard strategies,” says Muntoni.

“Now, thematic investing can be accessed by a broader consumer base. Once they make the changes necessary to include ETFs in 401k platforms as opposed to mutual funds, ETFs are going to attract a tonne of AUM.”

Srivastava notes that in the US, the focus on payout structures like autocall is putting pressure on structure products providers to innovate.

“A self-directed investor is often more biased to investing in themes and a passive approach can deliver good value,” he says.

“If you look at the US insurance market, some of which is advisor-driven, you have to convince the advisor that a theme is real and has a place in the portfolio. It is important to identify themes that are long-lasting.”

Muntoni agrees that self-directed investors can benefit from a thematic approach as it can match their emotional investing side via narrower types of themes.

“People in general associate with stories and a narrative, so having a theme is particularly important,” says Muntoni. “To some extent, direct indexing is probably an extension of thematic investing/ indexing because you can look at a theme and go narrower in relation to the investor views. If you have one specific thing that you want to invest in, then you could chase that with direct indexing.”

This however, according to Muntoni, is related to the knowledge base and the desire to interact with the portfolio as opposed to somebody else doing it.

“I think that we often forget that the majority of the people prefer somebody else to choose and to create that story for them,” she says.

Going forward, MerQube will continue to focus on building its technology to increase speed to market and build new complex strategies.

“The technology is scalable so that we can achieve economies of scale with precision,” says Srivastava. “One of the things that that we see is that when you are in a big name, it’s difficult to shift your technology or to make tactical moves. We’re a technology provider by default and became an index provider because we serve the index space as well as the rules-based investing approach.”

According to Muntoni, the growth of indexing means that is going to become a commoditised tool to develop transparent strategies.

“We want to capitalise on the demand for custom strategies and thematic indices as our technology can power scalable solutions and achieve speed to market,” she says. “We are well positioned to offer clear benefits to product providers as we can create alpha strategies and produce better pricing. It will become more of a staple as we go forward.”

On the use of overlays, such as decrement or risk control, Srivastava notes that the decrement overlay hasn’t really caught on in the US market because the dividend risk which is very low on the S&P 500 which is the main underlying of structured products in the country.

In contrast, thematic baskets feature higher dividend risk, and they lend themselves better for an efficient use of decrement,” he says.

However, according to Srivastava , it is imperative that the retail audience buying products linked to decrement indices understand the difference between the decrement in points and in percentage.

“What you’re getting and what’s the outcome - it has to be made very clear,” he says.

The development of thematic indices mirrors the evolving economy and landscape

Vinit Srivastava, MerQube

Morningstar

We select themes based on equity research

Morningstar is growing its footprint in the structured products market on the back of new demand for thematic underlyings seeking to capture new trends and growth stories.

Morningstar, like Bloomberg, expanded its presence in the structured products market in 2022, with five of its decrement indices appearing across 33 products in France, Finland and Sweden. The indices which include the Morningstar DM Europe Large-Mid Oil & Gas Decrement 50 Point Index and Morningstar Eurozone 30 Basic Resources Banks Energy Decrement 50 GR EUR Index which sold US$60m and US50m, respectively, also had a thematic profile.

The best-selling thematic index from Morningstar in the structured products market over the last two years was the Morningstar Exponential Technologies ESG Screened Target Volatility 7% Index which sold US$65m.

According to Julien Thibaud, global head of derivatives & exchange business development for Morningstar Indexes, the term thematic means a lot of things for clients and index providers - some people classify ESG as a theme and others will call an index thematic if it relates to megatrends.

“There isn’t really a common and strict definition of thematic, but there is at least some consensus in the market,” he says. “The way we classify thematic under our index offering tends to be related to megatrends or any themes that will have an impact in the future and can be durable and lasting for investors.”

Historically, thematics were captured through a sector or revenue-based approach, which tends to be the same, essentially - looking at the past in order to identify a theme, a company or trend and then make the assumption that something that has happened overtime will be relevant to that theme in the future.

“Our approach is different in that is based in extensive equity research,” says Thibaud. “Our index business has created a bridge with Morningtar’s equity research team to incorporate their fundamental insights on the investment theme into the index methodology.”

According to Thibaud, when designing thematic indexes

Morningstar looks at the term “thematic exposure” in a slightly different way.

“The index framework enables us to build indexes with bigger thematic purity and ultimately empower client success,” says Thibaud.

Do you consider ESG as an investment theme?

If we think of thematics in a wider way, ESG is an area that fits into the thematic bucket as it focuses on a diverse set of sustainable development goals (SDGs) with different environmental, social and governance sub-themes.

This area is still difficult to measure and there is a need for more robust index approaches to measure the activities of the different companies in relation to this framework. In order to assess whether a company is linked to one or multiple SDGs – we decided to rely on a revenue-based approach which has the benefits of being objective and transparent. However, revenue thresholds are still somehow limited which in turn has an impact on the index universe alongside with the liquidity and tradability of the underlying. This is a common limitation which, throughout time and ongoing companies’ alignments efforts, will hopefully be reduced.

What developments around Morningstar’s thematic index offering would you highlight?

Morningstar has developed several thematic indices for structured products providers over the last two years.

The Morningstar Exponential Technologies ESG Screened

Target Volatility 7% Index is a good example of the incorporating an ESG filter into a thematic index. This index is used by HSBC as the basis for a structured product offering. The index is designed to provide exposure to companies positioned to experience meaningful benefits as a user or producer of promising technologies while using ESG data from Sustainalytics to screen for ESG risk.

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SGX Index Edge

Decrement falters in Asia

SGX Index Edge has seen increasing demand for environmental, social, and corporate governance (ESG) and sectoral decrement indices in the European structured product space over the last few months, according to Mohit Baheti, head of SGX Index Edge (iEdge).

The company is owned by Singapore Exchange (SGX) after the acquisition of Scientific Beta in 2020.

One popular pick is the iEdge ESG Transatlantic EW 50 Index, which tracks the performance of European and US-listed companies that contribute the most to the achievement of the United Nations Sustainable Development Goals (UNSDG) by having a positive impact on environmental and social issues.

Beyond the ESG and sustainability theme, artificial intelligence (AI) and healthcare themes have gained traction among structured product issuers, added Baheti.

However, the index arm of SGX has seen less demand for decrement indices in Asia where technology underlying stocks dominate compared with Europe.

“Decrement indices are more popular in Europe compared to Asia,” he said. “In Asia, equity-linked structured products are primarily issued on single stocks, basket of stocks and traditional benchmark indices. Custom indices form a small proportion of underlyings used for structured products.”

Many of the single stock-linked structured products feature technology sector exposure where the “dividend payout is small and hence decrement indices are less relevant”. Investor education is critical for issuers to promote decrement indices among other sectors, according to Baheti.

“In Singapore, we see a lot of interest in sectoral and thematic indices. One example is the iEdge SREIT Leaders Index which gives exposure to the largest and most liquid real estate investment trusts in Singapore,” he said.

Singapore real estate investment trusts (REITs) remain resilient and continue to provide investors with passive income and attractive dividend yields.

“This makes them quite a popular strategy for structured product issuers in Asia as a standalone product or part of a cross-asset product,” said Baheti, noting that the iEdge S-REIT Leaders Index is also available with low carbon or ESG overlays.

At SGX iEdge, the decrement overlay is offered through customised indices and equity baskets. on thematic, sectoral and single stock indices.

According to SRP data, there are over 240 products tied to a total of 33 iEdge indices across markets - France (226 products), Finland (16) and UK (one). The majority of indices have a decrement overlay. The most recent launch - an autocalle note issued by Natixis in the UK market with a sixyear tenor – is linked to iEdge ESG Transatlantic SDG 50 EW Decrement 5% NTR Index.

The momentum of decrement indices in the equity-linked structured product market is partly attributed to investors’ need to hedge dividend risk, which “became even more significant after unprecedented dividend cuts during the Covid-19 pandemic,” said Baheti.

The growth was further fuelled by the low interest rate environment before the Fed’s rate hikes as structured product issuers were looking for products to deliver cheaper optionality.

With decrement becoming widely available in the market, SGX iEdge has put increased emphasis in clarifying to investors the difference between of the fixed percentage deduction and the index points deduction, according to Baheti.

“Another way of interpreting decrement indices is to draw parallel with price return indices,” he said. “A total return index can be seen as a combination of price return and dividend return (variable), or a combination of decrement index return and fixed synthetic dividend return.”

Depending on whether the fixed synthetic dividend is greater or less than the realised dividends, the decrement index could underperform or outperform the corresponding price return index.

“It is desirable to have a decrement level which is aligned with expected realised dividends to have a return comparable with price return index,” concluded Baheti.