The Futures are International
International portfolio diversifi cation and the increasing globalization of markets have validated CME Group's strategy of pioneering futures contracts based on international indexes.
CME Group has been a leader in connecting customers around the world and developing global products. In September 1990, the exchange introduced Nikkei 225 futures - the first time a U.S. derivatives exchange launched a non-U.S.-based stock index. This contract gave traders exposure to the most heavily traded names on the Japanese stock market, as well as a way to express their views on the dollar versus the yen.Since the launch, more than 8.7 million Nikkei 225 futures contracts have traded, representing a notional value of $546 billion. Volumes jumped in 2004 after the exchange began offering a yen-denominated contract, in addition to the dollar-denominated Nikkei futures. Both contracts now trade between 15,000 and 25,000 contracts per day. The need for international index-based products has only increased since the Nikkei futures were introduced. The globalization of markets means customers need to diversify their portfolios internationally, as well as with a variety of asset classes.
"Index futures allow traders to express a global equity view, and having a huge range of global index products traded on one platform allows customers to achieve synergies and operating efficiencies," says Scot Warren, CME Group managing director of equity products.
A FUTURE FOR INDEXES
CME Group is an established leader in U.S. equity index futures. More than 90 percent of all U.S. equity index derivatives trading takes place at the exchange. Trading futures on an index has advantages over other ways of gaining exposure to a foreign market, such as trading the cash market or an exchange-traded fund (ETF). Replicating an index with futures - called "synthetic indexing" - requires far less effort than buying and holding a portfolio of stocks that attempts to replicate the index. Also, institutional money managers always want to minimize tracking error when trying to replicate the performance of an index - in other words, to ensure that the derivative moves exactly as the cash index moves. Futures have a lower tracking error than alternative methods because there is no management fee component, as there is in an ETF. Index futures are not subject to the stamp tax on equities in certain countries. And roll costs for index futures have decreased recently, mostly because higher liquidity has made the product even more attractive to institutional investors. According to George Panos, Newedge deputy head of research, Americas, another aspect of index futures that makes them attractive - particularly for U.S. customers - is that they deal in a single currency, U.S. dollars. For futures users, they can be more margin-efficient than having several positions on different exchanges.
Following the success of the Nikkei futures, CME Group broadened its Asian index family by launching the S&P Asia 50 Index in 2006. This is the only pan-Asia equity index that tracks the 50 largest stocks traded in Hong Kong, Korea, Singapore and Taiwan. (There are currently no futures traded in China.) CME Group has had an exclusive licensing agreement with Standard & Poor's to trade futures on many S&P products. The Asia index was the first contract launched after the exclusive license was extended and expanded. It is traded exclusively on the CME Globex electronic trading platform.
E-mini MSCI EAFE index futures further broadened the range of CME Group's index futures in 2006. The MSCI EAFE Index, created in 1969, is the preeminent benchmark for money managers. It comprises stocks traded in Europe, Australasia and the Far East, offering investors a variety of trading and portfolio management strategies in the developed international equity markets. About $1.5 trillion is benchmarked to the EAFE Index globally, including the second largest exchange-traded fund in the world.
The EAFE is a multi-time zone product. Without the index futures, customers could buy a future in a given country, or a basket of stocks, but they would have to have a 24- hour, five-day-a-week operation, Warren says. Trading in the contract has been growing steadily. Average daily volume for June 2008 was 2,535 contracts, a 97 percent increase over June 2007. Panos says he thinks it would be traded more heavily if it weren't for the liquidity Catch-22. ("People will only trade where the liquidity is, but you can't get liquidity until people trade.") A complement to the EAFE futures, the MSCI Emerging Markets (EMI) index futures have been growing at a faster pace than the EAFE. Though a relatively new product - they were introduced in October 2007 - EMI futures' open interest is already higher than the EAFE's was in a similarly early period.
The index contains more than 850 leading securities of the largest and most liquid companies from 25 emerging market countries. It measures equity performance in some of the fastest-growing global economies, and is used in a variety of trading strategies.
MARKETS EMERGE
Panos attributes its rapid growth to the lack of a viable alternative in the emerging marketplace. Several countries on the emerging markets list are awaiting action by the U.S. Commodity Futures Trading Commission that would enable such contracts to trade in their countries.
"Current market conditions might also play a role," Panos says. "Emerging markets are hot now, so people want to gain exposure." And the index has been performing well, Warren says. "The year-to-date price return for that index is only down about 3 percent, compared to the U.S. large-cap indexes, which are down about 8-12 percent. For managers, who are always chasing alpha, this is the better performer."
Traditional managers (pension plans or mutual funds) and alternative managers (hedge funds or commodity trading advisors) use futures on indexes in slightly different ways, Panos says. "Traditional managers tend to use futures to replicate or hedge assets. Alternative managers tend to use them for speculation and for leverage." Alternative managers can also engage in long-short strategies: for example, a manager who held the view that emerging markets would outperform developed markets, but didn't want global systematic risk, might go long $100 million in the EMI and short $100 million in the EAFE, Panos says. "Being long and short means that even if all the markets go down and the EMI doesn't go down as much, you're okay. You can do that with any of these indexes," he adds.
In addition to the index futures it has launched, CME Group also plans to host other exchanges' index products on its platform. The exchange is partnering with Brazil's BM&FBOVESPA, the leading exchange in Latin America, to connect its products to CME Globex - including futures on the exchange's benchmark indicator, the 50-stock Brazil Index 50. The Brazil market has outperformed U.S. equities recently, making its stock indexes particularly attractive.
CME Group also expects to have in place an agreement with the Korea Exchange to list KOSPI 200 futures, one of the most actively traded contracts in the world, on CME Globex. The index comprises the 200 largest publicly traded companies on the Korea Exchange. This would be the first third-party agreement the Korea Exchange has undertaken for its KOSPI 200 product.
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