S&P Indices says its risk control index family can be an attractive new tool for European investors, given uncertain and volatile investment conditions.
There has been significant growth in structured product issuance since the launch of the S&P Risk Control Series in early 2010.
The risk control concept seeks to provide a visible and straightforward control which can be reflected in cost effective investment products.
During times of heightened volatility, there is an increased demand to control risk, but there are still only a limited number of investment techniques to efficiently manage risk, as opposed to simply diversifying risk through asset allocation.
The S&P Risk Control Indices use an existing headline S&P index, such as the S&P 500 or the S&P Europe 350, plus an overlying mathematical algorithm designed to control the level of risk by varying exposure to an underlying index based on systematic rules.
By setting a specific volatility target and managing the exposure relative to the underlying index, this framework controls the level of risk.
Typically, the risk control index consists of a position in an underlying index plus a cash position. If the risk level reaches a threshold that is too high as measured by index volatility, the cash level is increased to maintain the target volatility. If the risk level is too low, the risk control index will employ leverage to increase exposure to the underlying index to achieve the targeted level of volatility.
The exposure to the underlying index is calculated by dividing the target risk level by the realised volatility of the underlying index. The target risk/volatility threshold is set as a percentage and is typically five per cent, ten per cent, 12 per cent, or 15 per cent.
S&P Indices currently offers risk control indices in USD and Euros as well as the respective local currency for developed markets (S&P 500, S&P Europe 350, S&P/ASX 200, S&P Asia 50, and S&P Nordic LargeCap), and for emerging markets (S&P BRIC 40, S&P BRICT – which adds Turkey – S&P Latin American 40, and S&P Southeast Asia 40).
Gareth Parker, director, index research and design at S&P Indices, says: “This is not in fact a complex product, once you grasp the key point about a specific volatility target, and that’s been the key to its increasing use in Europe. Financial institutions have found these risk control indices versatile in helping them to engineer and issue cost-efficient products that investors may find attractive.
“In essence, this risk control methodology represents an innovation in-tune with today’s markets that may assist investors looking to maintain exposure to a particular market, investment theme, or strategy, while seeking to control their downside risk.”