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Q&A with Eurex and Qontigo
In June this year, Eurex listed futures on three STOXX thematic indices from Qontigo: the STOXX® Global Breakthrough Healthcare, STOXX® Global Digitalisation and STOXX® Global Digital Security. These derivatives target the beneficiaries of long-term structural trends transforming our modern economies and societies, and break new ground in one of the most popular investment segments of recent years.
To learn more about this first-ever listing of thematics derivatives at Eurex, we sat down with Zubin Ramdarshan, Head of Equity & Index Product Design at the Frankfurt-based exchange; and Yang Wang, Head of Thematic Index R&D at Qontigo.
Thematic investing has seen huge growth in recent years. What do listed futures at Eurex bring to the table for investors?
Zubin: “What the futures bring is an instrument to gain, manage and hedge portfolio risk and exposures in the growing thematics space, with the advantages of a standardized, liquid and centrally-cleared market. The contracts will specifically complement and support trading of existing ETFs tracking the three indices, as well as facilitate a natural progression for traders of sector derivatives.”
Yang: “Having derivatives will further stimulate the adoption of thematic portfolios. Index-based thematic products have seen quick adoption to target structural and disruptive trends with strong momentum. At Qontigo, we’ve had a leading role in building the global thematics offering. Eurex can play a similarly important part in introducing innovative thematic products.”
How would an investor or trader typically use thematic futures? How do they differ from, for example, sector-based futures?
Zubin: “We expect to see investors and traders adopt thematic futures to replace swaps, and to support trading in ETFs and other exchange-traded products, as it has historically happened in other segments, with market participants benefitting from the advantages of listed derivatives.
Thematic investing has had a lot of success as a targeted and accurate way to harness megatrends in a way that you cannot do with sector-based investments. Exposure to those companies driving megatrends must be specific and nuanced. If you take, for example, a Technology sector future, it is so broad that you may be targeting the desired theme, but you also get significant, unwanted exposures. Eurex’s sector derivatives segment has been very popular, and thematic derivatives can equally meet existing demand from investors.”
The new futures track three themes with a technology focus: breakthrough healthcare, digitalization and digital security. Why have you chosen these, and can we expect to see other themes listed in the near future?
Zubin: “The thematic segment will continue to grow as it provides investors a different alternative to tackle returns. Together with our partner index providers, market makers and banks, we want to offer the final investor the products that best fit their needs. In the segment of thematic investing, this means offering solid and well-researched themes. We started with technology-related themes, where we felt there was a need for exchange-listed derivatives. As the segment grows, we will continue looking at new possibilities.
More specifically, and continuing within the technology space, we are looking to launch futures on the STOXX® Automation & Robotics Index. And there are themes such as electric vehicles and smart city infrastructure, which have seen strong demand on the ETF side and should be well complemented by derivatives.
Elsewhere, there are environmental themes, such as the circular economy, energy transition or biodiversity. Given Eurex’s successful rollout of derivatives tracking ESG versions of established equity benchmarks, thematic ESG futures appears as a natural area of expansion. As always, we will consider the investment scope and the durability of the theme to guarantee an efficient product.”
Yang, Zubin just mentioned liquidity, which is an important requirement for an efficient derivatives market. How do the underlying indices address that?
Yang: “All STOXX indices are designed to ensure tradability and replicability, and the thematic indices are no exception. We apply minimum daily trading and market capitalization filters in the selection of stocks into all thematic indices. This is of paramount importance for all underlyings of financial products, in order to limit replication tracking error and costs.”
And can you tell us a bit more about the STOXX thematic indices?
Yang: “Qontigo’s STOXX Thematic family includes over two dozen indices categorized within the three broad megatrends of future technology, socio-demographics, and sustainability & climate. Each index has been carefully selected for its multi-year outlook and follows a transparent and rules-based methodology. The indices already serve as underlying for ETFs and structured products, so we welcome the extension to the exchange-traded derivatives space.
The three indices chosen by Eurex follow a revenue-based methodology, as they select stocks based on their sales exposure to the theme in question. We are able to use FactSet’s granular Revere Business Industry Classification System for this, thanks to our open architecture.
The STOXX Global Breakthrough Healthcare, STOXX Global Digitalisation and STOXX Global Digital Security are all derived from the STOXX® Global 1800 Index, a broad benchmark. The three thematic indices currently have between 115 and 220 stocks each.”
Talking of filters, the thematic futures also exclude companies in breach of certain ESG screens. Why is it important to have a sustainability filter in thematic strategies?
Yang: “As you know well, sustainability criteria have become a default requirement for many, if not most, institutional investors. Certain economic activities are undesirable from a sustainability standpoint, and investors also want to stay away from companies that breach global norms.1 We work closely with clients from idea generation to launch, and can adapt and tweak our products, so they are indeed tailored solutions for our clients. As we introduce thematic indices, we have made them ESG-compliant from day one, so investors can adopt them knowing they are also observing their internal policies.”
Looking at a thematic index, how does it compare to a traditional sector index?
Yang: “That’s an important question that most clients ask. Traditional sector indices rely on certain industry and sector classification systems. Many different systems exist for this purpose. While they are excellent tools to provide investors insight into company business activities, they lack the flexibility and granularity to capture trends and themes, particularly emerging themes. Qontigo’s thematic indices assess companies on their individual revenue categories. Only stocks that have more than 50% of their revenue derived from business activities associated with the theme are selected, underpinning the purity of the thematic portfolio. The methodology allows the systematic selection process to capture themes in a timelier and more precise manner, far beyond the capability of traditional industry classification systems. To illustrate that: the STOXX Global Digitalization index is less than half (46%) invested in technology stocks, with the remaining share allocated to companies in the Industrial Goods & Services, Retail, Media and even Real Estate sectors, among others. That compares with a 100% allocation to technology stocks in the case of the STOXX® Global 1800 Technology index.”
As you mentioned earlier, Zubin, the three STOXX thematic indices behind the futures also underlie respective ETFs. How do the two products coexist?
Zubin: “The introduction of futures leads to more efficient markets overall — with improved price discovery, enhanced transparency, and a new leveraged alternative for market makers to hedge their risks. In the end, bid/ask spreads will tighten.
The empirical evidence is clear that index futures can really complement the liquidity picture for an adjacent ETF based on the same or similar index. Take the case of the STOXX® Europe 600 ETFs, which have grown in terms of AUM, all while a futures market with global interest and reach has developed robustly.”
To conclude, 2022 has been a testing year for many thematic strategies. How has the macroeconomic uncertainty affected thematic investing?
Zubin: “It is true that 2022 has been a difficult year for most areas of the market, but particularly so for growth-oriented sectors. Thematic investing is about tracking trends that have the scope to grow and play out over several years and exceed the traditional economic cycle. Themes such as digitalization and breakthrough healthcare will not come to a stop because of higher interest rates or a slowdown in economic growth. On the contrary, these are the moments when investors with a long-term horizon can reassess their thematic positioning and take advantage of better prices. In the meantime, they will need to hedge their thematic portfolios against volatility and tactically manage their exposures. They now have futures to efficiently do so.”
1 Exclusionary screens cover companies in breach of global norms as identified by Sustainalytics and those with ‘Controversy’ ESG ratings. Also excluded are companies that obtain sales from Controversial Weapons, Tobacco, Conventional and Unconventional Oil & Gas, Thermal Coal, Nuclear Power, and Small Arms and Military Contracting.
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