The move towards increasingly complex, passive investment has been a boon for index providers with the capacity to express strategy in sophisticated indexes. Data provider ETFGI estimates $647 billion was held in smart beta exchange-traded funds at the end of April 2018, which had been the twenty-seventh consecutive month of inflows into such strategies.
“In the last couple of years, we have seen increased demand for more strategic styles of indexes that we have created based on market feedback,” says Sam Tsui, head of market development for Asia-Pacific at S&P Dow Jones Indices. “Firms are looking at particular strategies, and they want an index provider to customise those strategies. That is moving from using indexes as a broad market benchmark to using them for investment objectives.”
This marks a substantial increase in the complexity of index construction, representing defensive and aggressive elements that are more common in structured product contracts.
“Increasingly we have seen investor interest in multi-factor strategies,” says Tsui. “Our research team has had to understand how we can blend different factors together, how factors perform differently in different market conditions, and how we can build indexes with factors that provide investors with downside protection, or gain premium earnings when the market goes up. Those are the challenges in optimising the strategies.”
However, the Asia-Pacific region poses a particular challenge for businesses seeking to provide both customisation and scale. To operate effectively, providers must deliver across a wide range of different markets to meet a range of very different investor needs depending on levels of sophistication.
Furthermore, such structures are rarely fungible between markets due to individual market rules that exist in each Asia-Pacific jurisdiction. Index solutions must therefore demonstrate local expertise of market composition to benefit the global investor community.
For example, when tracking the China market, several index providers track China A-Shares, which are listed on one or both of the mainland exchanges in Shanghai and Shenzhen. However, that does not include major Chinese firms that have a considerable domestic revenue stream but list elsewhere, such as Baidu, Alibaba and Tencent.
“If you really want to have an overview of how the Chinese market is evolving and growing, you have to capture companies like that in the index,” notes Tsui. “That is why we created the S&P China 500 index, which takes in the largest 500 Chinese companies listed anywhere in the world. You cannot just assume locally listed shares will represent a country’s economy.”
For S&P Dow Jones Indices, which says it launched 130 new Asia-Pacific and emerging markets indexes between April 2017 and March 2018, finding a way to maintain local knowledge that can be shared across the organisation, without creating siloed bottlenecks, is a real operational challenge.
“We are calculating more than a million indexes a month, so we need both expertise and investment in technology,” says Tsui. “Our company has a very robust team of index management experts. We have the team in various locations in Asia, such as in Beijing, where our China index managers are based, and in Australia we have increased the headcount to deal with the growing number of indexes we are managing.”
The firm is also building out its capacity to automate modelling. In March this year, parent S&P Global acquired Kensho, an artificial intelligence technology company, which will be used to support analysis and portfolio construction by processing enormous datasets.
“There are a few State Street exchange-traded funds, currently available in the US, which are based on Kensho data and indexing,” says Tsui. “That acquisition will have benefits for our business, as we can potentially leverage those capabilities by bringing together big data analytics and index construction.”
The firm has bought in further expertise via its 2016 acquisition of Trucost, a provider of carbon and environmental data and risk analysis, which has underpinned the development of indexes supporting investment that upholds environmental, social and governance (ESG) principles. This provides analytical tools for both investors and corporates to enhance ESG transparency.
“The implied costs associated with environmental risks, such as leakage of water or carbon emissions, can cost the companies responsible a lot of money,” notes Tsui. “This will eventually have an impact on the earnings of those companies, so it is important for the corporates to understand their carbon exposure. On the other hand, investors increasingly need to understand the carbon emission levels for corporates in Asia.”
Bringing together its organically developed and acquired resources has enabled S&P Dow Jones Indices to overcome the challenges of scaling-up expertise across the Asia-Pacific region, impressing the awards judges through a wide range of innovative new products.
The week on Risk.net, September 8-14, 2018Receive this by email