What are Quantitative Investment Strategies (QIS)?

QIS are generally wrapped in the form of indices. These indices are then referenced within our existing structured note or OTC products.

At Marex we have defined three distinct Index families, namely: Decrement, Futures Trackers, and Volatility Target:

Decrement

Futures Trackers

Volatility Target

1. Decrement

Definition: A Decrement Index is designed to provide a return that is adjusted for a specific decrement rate.

 

Key Features:

Decrement Adjustment

A Decrement Index is constructed by subtracting a pre-defined synthetic dividend from the index (calculated on a daily basis with respect to a specific daycount convention)

Method

Decrement indices use two different methods to deduct the pre-defined dividend: fixed percentage deduction or fixed-point deduction. Within Marex-published indices, we only make use of fixed percentage methodology.

Benefit to the Investor: By incorporating a deterministic synthetic dividend, decrement indices can potentially enhance the yield of structured products linked to them. Additionally, the level at which an Issuer is pricing the dividends of an index is much more transparent with a fixed decrement compared to a standard ‘vanilla’ index request. Investors can also choose a unique decrement level allowing them to tailor the resulting option price in order to match their risk and return preferences.

Risk to investor: A Decrement Index will underperform conventional indices when the synthetic dividend is materially higher than the actual dividends paid out from the underlying index.

Conclusion: Decrement Indices reduce the uncertainty of future dividends by fixing the dividend level at a deterministic yield. This eliminates dividend risk for the issuer and enables resulting products to be priced more aggressively and transparently, which in turn may enable a higher yield and or improve capital protection features for the investor.

2. Futures Trackers

Definition: Futures Trackers are indices designed to track the performance of futures contracts on a specific underlying asset or commodity. This is done by ‘rolling’ futures contracts as they approach expiry in order to maintain a continuous exposure. Depending on the relative liquidity, transaction costs and margin requirements associated with the target futures exposure, some indices may embed a ‘transaction cost’ parameter which deducts a fixed percentage from the performance of the index.

 

Key Features:

Continuous Exposure to a Desired Futures Contract

The index typically tracks a single futures contract within a particular asset class, such as a specific commodity, currency pair, equity index, government bond or interest rate. The Index reflects the price changes of the underlying futures contracts, naturally embedding the roll costs arising from the shape of the futures curve (e.g. due to backwardation or contango effects).

Bespoke Rolling Strategies

Indices can be produced which target specific roll periods (e.g. selling the second month and buying the fifth month future of a particular chain). This flexibility can enable so-called ‘optimised’ roll yields, which intend to benefit from congestion around specific roll dates caused by underlying hedging pressures from physical markets and/or known inefficiencies created by the existence of other products (such as the BCOM Indices).

Benefits to the Investor: A Futures Tracker aims to provide investors with a way to gain exposure to the price movements of the futures contracts without directly trading the futures contracts themselves. Futures Trackers are liquid, transparent and typically low cost to create and maintain. They are often used as the building blocks for more complex QIS which may involve taking long and short positions in different futures contracts.

Risk to investor: The index may not perfectly track the performance of the underlying futures contracts due to factors such as the cost of rolling contracts.

Conclusion: A Futures Tracker Index seeks to provide a linear, rolling exposure to a chosen futures chain, with a pre-defined mechanism to facilitate the movement of exposures from one futures contract to another.

3. Volatility Target

Definition: Volatility Target indices (also known as “VolTarget” or “Risk Control”) are designed to maintain a specific level of volatility in a target asset, regardless of market conditions. It achieves this by dynamically adjusting the exposure to the target asset based on (typically) a realised volatility measure (e.g. a short-term standard deviation calculation). When volatility rises above the target level, the index systematically reduces exposure (by increasing allocations towards cash or other less volatile assets) and when volatility is below the target the index will increase exposures towards target assets (in some cases employing leverage).

 

Key Features:

Volatility Adjustment

The indices systematically modify exposures in a pre-defined, dynamic way in order to maintain a targeted level of volatility.

Benefit to Investor: By attempting to stabilise the realised volatility of a chosen asset(s), these indices can often be structured to achieve a better risk-adjusted return compared to a direct investment in the target asset(s). (2) The existence of a volatility target feature may also enable Issuers to create non-linear products on an asset for which no liquid options markets exist (e.g. Mutual Funds, ETFs, Fixed Income underlyings). Similar to Decrement Indices, the volatility target level can be adjusted to facilitate a specific budget, resulting in bespoke investment products that are tailored to individual requirements.

Risk to investor: The process of adjusting allocations to target a specific volatility level may not always be timely or accurate. Rapid changes in market conditions can lead to suboptimal adjustments and unintended risk exposures. Additionally, implementing a volatility targeting strategy can involve frequent rebalancing and potentially higher transaction costs. Although the concept of volatility targeting is widely used across the industry (for many decades) and all indices are transparent and fully replicable, the calculation of the index requires a robust calculation methodology, the replication of which may pose a challenge to less sophisticated investors.

Conclusion: Volatility Target Indices can help in managing and stabilising returns through a dynamically adjusted exposure which targets a specific asset(s) – the existence of this methodology can also facilitate non-linear investment products in non-equity asset classes.