Yield Enhancement Using Equity Index Futures

A capital-efficient way to achieve U.S. equity market exposure

Non-U.S. investors can gain exposure to U.S. equity markets in a variety of ways. All vehicles for the same exposures are not the same, however. The nuances can make a sizeable difference in the performance of the position.

It is particularly true for those segments of the equity market in which dividend income plays a relatively big part of the total investment performance, e.g. the utilities or the real estate sectors.

Take E-mini S&P Utilities Select Sector Index Futures as an example. The S&P Utilities Select Sector Index current spots a dividend yield of approximately 3.5%. A non-U.S. investor holding an exchange traded fund of the index, for example, would be subject to a dividend withholding tax of as much as 30%.1 As such, the net dividend received could be 105 basis points lower.

Contrast that with gaining synthetic exposure using E-mini S&P Utilities Select Sector Index Futures. During the March-June 2015 quarterly roll period, the index futures traded at an implied funding rate of approximately 3-Month LIBOR plus 8 – 17 basis points.2 In return, investors received the index price performance and 100% of the expected dividend returns.

8– 17 VS 105 BASIS POINTS. THE CHOICE SEEMS CLEAR.

Further, index futures are unfunded instruments, so non-U.S. investors do not face FX risk on the notional value of the exposure with index futures. CME FX futures can be deployed as an overlay to tailor-make the desired level of FX risk.

References

1. Investors domiciled in countries which have tax treaties with the U.S. might be exempt or subject to a lower dividend withholding tax rate.

2. The financing rate embedded in the futures price is determined by market forces and can fluctuation significantly due to market conditions

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