APCIMS non-UK Equity Exposure and Structured Products
11 June 2010
Anyone who uses APCIMS knows that their two benchmark equity indices are the FTSE All Share and the FTSE World Series Ex UK.
Most structured products based on a UK equity index are structured on the FTSE 100 Index. The reason for this is twofold. Firstly, whilst not the FTSE All Share, it is very highly correlated to it, so investors trading the FTSE 100 are comfortable that it will track their APCIMS benchmark closely. Secondly, in the interbank derivatives market, it is the most liquid UK equity index, which enables the banks to hedge any derivative exposures that arise from trading structured products most efficiently. For these two reasons the index suits both providers and users of structured products.
Unfortunately there is not a similar overlap for providers and users with respect to the Ex UK benchmark. There is simply not a derivatives market on this index. Some banks make markets on the MSCI World (or ETFs on the MSCI World), which is not a bad proxy, but it is still not the most liquid derivatives underlying. So this has led us to look for alternatives.
In the derivatives world, the most liquid global indices are the S&P 500, the EuroStoxx 50 and the Nikkei 225. In fact, large volumes and sizes of derivatives are traded on baskets of these three indices. In derivatives parlance, this basket of three indices is known as the ‘Global Basket’.
So, we looked at how well correlated this Global Basket could be relative to the Ex UK APCIMS benchmark.
Through an iterative process we found that over the last 10 years a basket of 50% S&P 500 (Total Return), 35% EuroStoxx 50 (Total Return) and 15% Nikkei 225 (including the relevant currency exposure versus GBP) is extremely highly correlated to the APCIMS benchmark, as the graph below shows.
We actually calculated the correlation to be 99.57%, which was a lot closer than we thought we would find.
To summarise, therefore, we believe that structuring products on the Global Basket in these weightings might offer a good ‘underlying’ for those using APCIMS as their benchmark, as the basket seems to be highly correlated to APCIMS and the indices within are the most liquid in the derivatives market.
This might come as a surprise to some, particularly those historically not fond of the EuroStoxx 50.
An example of a product we have traded on a basket similar to this can be found here.
Andy Lakeman
