Asset managers have told TABB Group that they are focusing more attention on index derivatives as market structure changes in both OTC and cash markets are impacting their portfolio decisions.

As they change the way they manage cash flows and risk exposures, index derivatives are seeing greater growth as part of the evolution of existing strategies, already generating record level volumes on multiple days in October 2014.

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According to Matt Simon, a TABB principal, head of futures research and author "US. Equity Index Derivatives: The Next Phase of Institutional Discovery," traditional drivers of equity-index based derivatives usage will persist, evolving over time with asset managers using index products to equitize cash, hedge risk, gain exposure to underlying reference markets and search for new ways to gain alpha when provided with the right opportunities. "If recent volumes during October are any signal of what to expect in 2015, the changes for increased adoption are already taking hold."

This growth potential has not gone unnoticed. "The recent announcement by the London Stock Exchange (LSE) concerning its acquisition of Frank Russell and its lucrative index operations for $2.7 billion highlights the current appeal of owning an index business," says Simon.

For this study, which covers market validation; the most active products; electronic order routing; brokerage routing decisions; executing brokers’ market share; trading product selection; and regulatory impact, TABB interviewed 26 firms, including long-only asset managers, hedge funds, commodity trading advisers (CTAs) and pension managers with $6 trillion in total Assets under Management (AuM).

It also includes interviews with sell-side trading desks, market makers, proprietary trading firms, technology providers and exchanges, conducted during the second quarter 2014.

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Top findings include:

  • 92% of long-only funds, hedge funds and CTAs say their equity index derivatives volumes will increase over the next year.
  • E-mini S&P 500 remains the most active futures contract by a wide margin with SPY the leading options index product, January-September 2014 vs. January-September 2013.
  • Nearly 60% of buy side trade through clearing broker(s).
  • For brokers, cost of execution and service levels are most important selection criteria.
  • Hedge funds and CTAs say they are interested in sophisticated trading functionality to support their derivatives activity; leading OMSs and EMSs received mixed results.

Rather than being used as a pure alpha generating tool, says Simon, hedge funds are using index products to manage the growing number of market risks. "Facing a more difficult operating environment, they’re not only being forced to improve their balance sheets and lower risk exposures, they’re being driven by pressure from their prime brokers to improve the management of their risk exposure."