What is behind increased use of interest rate and index products?

Published on 15 December 2023

Looking at the key drivers of risk in European and Asa Pacific markets this year, and the potential options for investors in order to position their portfolios to manage those risks, we see that interest rate and index products are proving increasingly popular instruments.

Mezhgan Qabool, head of business development and sales for APAC and Middle East at Eurex and Olivier d’Assier, head of applied research for APAC at Axioma, highlight the key indexes attracting investors, assess why are investors are looking at index futures, and the benefits that they are realising from a broader range of trading-hours being offered across time zones.

Transcript of interview:

Dan Barnes: Welcome to Trader TV – your insight into institutional trading. I’m Dan Barnes.

Investors across Europe and Asia Pacific are increasingly looking at index and interest rate products to help mitigate risk and manage returns. Joining me to discuss this trend are Mezhgan Qabool and Olivier d’Assier.

Mezh, Olivier. Welcome to the show.

Mezhgan Qabool: Thanks, Dan. Great to be here.

Olivier d’Assier: Thanks for having us.

Dan Barnes: What are the drivers of risk in the European market today?

Olivier d’Assier: So looking back, the big change for investors is obviously the rise in interest rates by the ECB last year. You know, for the last ten years investors were lending money to their governments and not getting anything in return. So the hike in interest rates has definitely been a game changer for some of them. And we’ve seen a lot of money pull out of equity markets and go into the fixed interest market to try to collect on that.

You couple that with the fact we have two active theaters of war now, we have a macro situation where the inverted yield curve led us to believe that a recession was imminent. It never came. We had a mini banking crisis of sorts. So uncertainty has been high all year round. And the way to mitigate that was to go to the safe end of the markets. And what we saw was concentration, and that led to a lot of the risk in the markets, so they huddled around banks which are a proxy for the economy. They look to luxurious goods because usually wealthy clients are not as affected as the rest of us in their spending. And some industrials, mostly around the technology side of things.

So that led to a lot of problems for investors, and they felt some protection by hedging that with derivatives. So we saw Euro Stoxx banks for example, outperform its broader blue chip here, the Euro top 50, which has a little bit more of sector diversification. And that itself also outperformed the broader Stoxx Europe 600 which has, you know, the full breadth of the market. So concentration has really been the game this year in Europe.

Dan Barnes: So how should investors position their portfolios to manage and mitigate those risks?

Olivier d’Assier: Obviously for investors the big question for 2024 is when will the ECB pivot to a more accommodative, even a more stimulative monetary policy? Fiscally, all the governments in Europe are kind of hard pressed, right? We just had Germany announce a spending freeze. The European Union just rejected France’s budget proposal. So you’re not going to get fiscal stimulus next year.

What you’re going to have to do is cut interest rates and let that drive the money back out of fixed interest, back into equities, and that money is going to be looking for bargains. So it’s going to be looking for something different than it did this year. It’s going to be looking for relative value. So banks and luxury goods might not be the favorite next year. We might see a broadening of the base of portfolios. So I would expect things like the Stoxx Europe 600 to outperform some of the more concentrated benchmarks that we have.

Dan Barnes: Mezh, we have seen EU extend its trading hours into the Asia Pacific time zone. What has been the rationale behind that?

Mezhgan Qabool: Risk management is one of the key drivers for us. We wanted to ensure that our products were available in the first time zone, which reacts to market news, geopolitical events and any price movements that are observed in a volatile market environment. Asia is the first time zone to react on these, and prior to having these products available, our clients were forced to proxy hedge themselves with other indices or interest rate products, which they no longer need to do as they have the European benchmarks available during their core trading hours.

Dan Barnes: How do you see adoption of these products in terms of activity and also liquidity in after hours trading?

Mezhgan Qabool: Looking back to 2019, the first year that we had the extended hours, we saw average daily volume of 29,000 contracts. Today, it’s about 60,000 contracts across the equity index products and fixed income products that we have available. This is a compounded 14% year on year growth. 70% of the current volume and the order book is by end clients, which is great, showing a healthy mix of investors participating into the extended hours. 30% is provided by our market makers and liquidity providers, who ensure that there are prices on the screen, as well as size for investors to be able to trade in amounts in the best managed manner.

If you look at the European benchmarks that we have, the euro stocks and index continue to play a dominant role within that liquidity portfolio. We do see more coming through the interest rate products, the Bunds, which is the German government bonds, and the FOAC, the French government bonds, given the current interest rates environment. We also have the MSCI portfolio available for trading during the extended hours. And here the Asia underlying all of these contracts are being traded for 40% of our overall global volume within the core Asia Pacific time zone.

Dan Barnes: That’s been great. Mezh, Olivier, thank you both so much.

Mezhgan Qabool: Thanks for having us.

Olivier d’Assier: Thanks, Dan. It was a pleasure to be here.

Dan Barnes: I’d like to thank Olivier and Mezh for their insights today, and of course to you for watching. To catch up on our other shows, including Trader TV This week at 6:45 a.m. UK time every Monday morning, go to TRADERTV.NET.