Environment & Social Governance (ESG)-related investments are now a general trend as a result of more emphasis on intangible assets when looking at equity investments, according to Robert Roe, a structurer at Commerzbank's London-based equity & hybrid derivatives structuring team, in the second part of an article about the increase in its ESG offering.
"Research now shows that higher adherence to ESG principles within a company can add value to a company," said Roe. "We have seen how scandals covered in the press can damage the reputation and the intangible value of companies and those views can filter down to clients."
However, performance remains a key element in the validation of ESG investing, especially for retail investors, who also look at the branding of an index, according to Varun Mahajan (pictured), European head of equity & hybrid derivatives structuring. "That's why it is important to choose the right partners," said Mahajan. "Given the early stage of the ethical segment, it can suffer from the lack of past performance records, but the selling point is associated to the underlying theme to which it offers exposure."
Nordic investors used to look only at the ethical nature of an investment and, if an index was ethical, that would be enough to for them, according to Remi Collignon, another structurer at the equity & hybrid derivatives structuring team. "However, this has now changed, and investors are now looking at what is in the index. This has also led to a more granular approach, and new opportunities to combine different concepts, such as ESG and the green economy."
The new ESG range is a complement to the existing offering, which includes products linked to the bank's proprietary indices. The bank calculates and markets its own index range as well as partnering with external index providers, according to Mahajan. "This approach allows us to develop a comprehensive product range and service a range of different clients," said Mahajan.
Smart beta and ESG combine well, according to Roe, who noted that the volatility-based weighting scheme in the index offers a defensive way to gaining exposure to a bullish index or strategy.
"The benefits of such a weighting scheme in an index are two-fold," said Roe. "Firstly, it leads to a more economical way to get exposure to an equity market (lower volatility equals lower price on options), and, secondly, low volatility stocks tend to outperform the benchmark over a period of time, and that is a well-researched anomaly in the stock market (low volatility stocks are related to more stable business models; they suffer less when markets go down)," said Roe. "Low volatility lends itself very well to this particular time, when investors are unsure about the direction of the equity market but have a bullish sentiment overall."
The lower price on options also allows the bank to provide more upside on the products it manufactures, making them more attractive to investors. "Low volatility is the most popular factor in the structured products market, because it makes sense from an investment environment perspective - investors can still benefit from exposure to the equity market without taking all the risk, and, from a product provider's perspective, because we can convert the cheaper optionality into better upside for the investor," said Mahajan.
The use of low volatility indices in the structured products market is a sign of the times, according to Roe. "The equity market is still offering value, but there is an underlying concern around downturns, so it makes sense to deploy a factor that allows investors to get access to the market in a defensive way," said Roe.
"The demand is evenly distributed in the three main regions (Asia, Europe & North America), and our goal is to build a range of products that resonate in every market," said Roe. There has been an increase in the number of reverse enquiries from clients in different markets, according to Roe. "Our own focus, however, for marketing this product range, is going to be Europe and the Asia-Pacific region, where we have very well-established relationships."
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