This article is based on a study conducted in the first half of 2018 by EQDerivatives, an independent firm that works with investors, portfolio managers and service providers active in equity derivatives markets. The article highlights findings related to the strategies deployed by Asian buyside rms, as well as global use of products based on Asian equity indices.
Each year, EQDerivatives conducts a “market mapping” analysis of the global equity and volatility derivatives market, including its potential for growth in the coming years. The analysis is based on the views of buyside firms around the globe: asset managers, hedge funds, pension funds, private banks, family offices and insurance companies. The findings and analysis provide a map of how equity and volatility derivatives are deployed by managers globally, as well as the types of listed and over-the-counter derivatives that they tend to use most frequently.
This year’s questionnaire received responses from 71 participants from April to July. Asset managers and hedge funds represented 82% of study participants. Pension funds were 10% and the remainder came from private banks, family offices and insurance companies. In terms of assets under management, asset managers accounted for three-quarters of AUM in this year’s report.
The total global assets under management for firms participating was reported at US$2,607 billion with U.S. and the Americas AUM coming in at $1,768 billion, Europe at $533 billion and Asia- Pacific at $306 billion. The total notional value of the equity and volatility derivatives deployed by these firms came in at US$1,158 billion. These firms use derivatives for a variety of strategies, but at an overall level, the primary purpose was to seek alpha, i.e., achieve a return higher than the market. That contrasts with the hedging strategies typically deployed by manufacturers, commodity producers and other end-users, which are generally aimed at protecting company revenues from exposure to price volatility. More than half of the survey respondents said they might allocate as much as 70% of their portfolios to alpha-seeking strategies, and only 32% said they would allocate no more than a third of their portfolio to alphaseeking strategies. Pension funds typically were the least aggressive; hedge funds the most.
In this article we focus on findings related specifically to derivatives use in the Asia-Pacific region. First we take a look at findings related to the popularity of various products based on Asian indices, then we look at the trading strategies commonly used by firms in this part of the world.
Trends in the Use of Asian Derivatives
Across the 71 institutions that responded to our questionnaire, the most popular Asia-based products were derivatives based on the Nikkei 225, Japan’s main stock market index. Thirty-three firms reported using these products, equivalent to 46% of our sample group. That compares to 64 firms using derivatives based on the S&P 500, the most popular set of products worldwide, and 46 firms using derivatives based on the Eurostoxx 50, the most popular European index.
Within the Nikkei 225 of products, 82% respondents reported using options, 76% futures and 42% OTC derivatives based on this index. That was not a common pattern; in most markets our survey respondents said they used futures more than options. It is also worth noting that these products are listed on three exchanges: CME Group, Japan Exchange and Singapore Exchange. Our survey respondents generally did not express a preference, but for those that did, CME came ahead of JPX by a small margin.
The second most popular class of products was derivatives based on the Hang Seng index, which tracks companies listed on the Hong Kong stock exchange. Twenty- four firms reported using these products, equivalent to 34% of all survey respondents and 69% of respondents active in Asia.
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It is worth noting that two indices that offer a competing way to gain access to China’s equity markets, the FTSE China A50 and CSI 300 indices, were not nearly as popular. Both track shares listed on the Shanghai and Shenzen stock exchanges, the two main onshore exchanges. Only seven firms reported using FTSE China A50 derivatives, which includes futures listed on the Singapore Exchange. And only five firms reported using the CSI 300 index, a much broader benchmark developed by the Chinese exchanges themselves.
Derivatives based on the Topix, ASX and Kospi indices ranked third, fourth and fifth respectively in terms of the number of firms using derivatives based on these indices. It is worth noting, however, that the firms using the Topix and ASX products tended to be larger in terms of assets under management. The firms using derivatives tied to the Topix index, which tracks small and medium-cap companies in Japan, reported $154 billion in AUM, compared to an AUM base of $99 billion using Hang Seng derivatives. ASX was even higher, with firms having $163 billion in AUM using those derivatives, which track the Australian stock market.
Currently, Asia derivative users obtain their volatility exposure either through index options or OTC contracts. In this year’s survey, we asked participants about their appetite for exchange-traded products designed to track Asian volatility, similar to the VIX and VStoxx products that have done so well at Cboe and Eurex. More than half of the respondents said they see a need for such a product, and pointed in particular to the Hang Seng and the Nikkei 225 indices. While such products have been listed on exchanges in the region, the respondents said there is not enough liquidity, and indicated that the products need a significant boost or a redesign to become successful.
Derivatives Use by Asia-Pacific Buysiders
The second set of findings relate to the use of derivatives by buyside firms that are based in the Asia- Pacific region. Although only 16 firms based in this region responded to our survey, the findings provide insights on the types of strategies used by these firms and the potential growth of this client base.
The overwhelming majority of our survey respondents said they expect to increase their use of equity and volatility derivatives in the coming 12 months, but the strongest responses came from our Asian participants. Respondents in that region said they expect to increase their use of such derivatives by 72%, a big jump from the 35% response we received in our 2017 survey.
In terms of trading strategies, the most popular among Asian firms involved the use of variance and volatility swaps. Almost 90% of our participants reported using this strategy, which reflects a global trend towards greater interest in volatility as an asset class.
When we asked how this type of strategy is deployed, we received a wide range of responses. Boiling these down, we came to three key points: they are used both systematically and tactically, they are often used in alternative risk premia implementations, and they are often used when the market is stressed. Unlike other trading strategies, variance/volatility were identified as mainstays in a user’s toolbox.
Correlation and dispersion strategies came next, with 63% and 56%, respectively. These two strategies rely on the use of swaps and are primarily used by hedge funds. Portfolio managers and traders that deploy dispersion strategies most often identified levels of implied correlation as being the reason they jump into the market. When levels line up with their models, they engage this tool. Most users noted that they use dispersion opportunistically and in a targeted fashion. Few reported using dispersion as a consistent, ongoing strategy in their portfolio.
Total return/equity repo swaps were used by 44% of Asian participants, which was the highest rate of use in any region. This strategy is commonly used by large asset managers, pension funds and sovereign wealth funds as a way of gaining passive exposure to equity markets without using futures or the underlying stocks. Asset owners in Asia-Pacific often use these swaps to gain exposure to markets outside their region.
We recently held a conference in Hong Kong to discuss trends in equity derivatives markets and investment strategies. Among the topics actively discussed were the potential for Nikkei and Hang Seng derivatives, the return of inflation and its effect on equity volatility risk, and the increasing sophistication of Asian-based derivative players. The level of attendance and interest at the Hong Kong conference corroborated one of our 2018 study’s key findings—that the growth in derivatives in the Asia-Pacific region will likely outstrip all other regions over the next 12 months.
Patrick Fay is head of research and consulting at EQDerivatives. He joined the firm in 2017 after spending more than two decades in the equity derivatives markets.