FTSE Russell: risk reduction appetite driving QIS in retail market

FTSE Russell’s market share in the structured notes market when it comes to strategy & custom indices, not considering decrement indices which now have over US$1 billion in assets under management related to structured products, has remained steady over the last two years and was driven by products sold in the US market linked to either the Russell 1000 Growth (10 products/US$203.99m), Russell 1000 Value Index (21 products/US$102.72m) and Russell 2000 Value Index (48 products/US$75m), according to SRP data.

Our clients are looking for new indices encapsulating the latest risk management technique or an innovative thematic -Guillaume Flinois

However, FTSE Russell is also seeking to increase its US footprint in the indexed annuity space. The index provider entered the US annuities market in 2015 and already has many US carriers proposing FIA or RILA contracts linked directly or indirectly to one of their indices, according to Guillaume Flinois, head of engineered products and Indices, FTSE Russell.

“The indices range from benchmark to more complex indices,” he said. “We want to do more in that space, and our clients are looking for new indices encapsulating the latest risk management technique or an innovative thematic.”

According to Flinois, the current focus is on launching indices under the FTSE Russell brand as opposed to acting only as a calculation agent “even though this is a service we also provide”.

“We have a long history of developing custom indices with investment banks, from custom equity indices encapsulating a specific data set or a more research-based construction to systematic strategies like risk control overlay or derivatives based QIS strategies,” he said. “One of our strengths is our capability to reduce some market risks like dividend or volatility through transparent engineering techniques”.

Andreas Schroeder, head of the European index research and design team at FTSE Russell, noted that the unique selling point of FTSE Russell’s custom indices is “flexibility backed by a deep understanding of signals and portfolio construction”.

We offer clients the ability to tailor indices to their specific requirements like factor exposures, sustainability outcomes, ESG overlays - Andreas Schroeder

“We offer clients the ability to tailor indices to their specific requirements like factor exposures, sustainability outcomes, ESG overlays, regional exposures or implementation constraints, said Schroeder.

“At the same time, we maintain transparency, and operational robustness. Our custom indices can serve as passive investment vehicles, building blocks for asset allocation and investment products as well as benchmarks for performance reporting.”

Flinois also pointed at the opportunity to embed protection via custom underlyings as opposed to the product payoff.

“Custom indices can be designed to incorporate protection mechanisms directly within the index, rather than relying on structured product payoffs,” he said. “That includes dynamic allocation rules like volatility target mechanism that de-risk in certain environments but also option overlays. We work together with leading QIS desks to understand the end-user requirements and provide solutions.”

FTSE Russell has been “busy” over the past few months on the risk control front with regular launches of custom indices linked to their flagship indices with a risk control overlay, “each of them being tailored to match the risk reduction appetite and the trading book model of the investment banks”.

The volume of custom indices, according to Flinois, is growing fast in every regions and it is natural for FTSE Russell “to keep helping our clients on the sell-side or the buy-side to further customize their index exposure”.

“This growth is driven by the need for innovative and differentiating content, optimized constructions, custom protection, compliance to regulatory constraints, etc,” he said. “That requires a lot of expertise across the board, a lot of data onboarding and partnership creation among market players. Tech improvement allows index sponsors to launch these custom indices faster while calculation capability allows index sponsor to access new content.”

From a research perspective, the current environment is “naturally the key driver of investors’ top-of-the-mind concerns” which include extreme concentration in the Magnificent 7, as well as uncertainty surrounding tariffs and their impact on the economies, growth and inflation, and the AI hype vs. disillusionment.

“We address all of these in our research and product innovation,” said Schroeder, adding that FTSE Russell’s answer to the extreme level of concentration in market cap weighted indices is ‘target diversification’.

Target diversification

FTSE Russell has developed a proprietary allocation methodology which incorporates diversification as a core part of benchmarking. “It is the next step in the evolution of benchmarking,” said Schroeder.

In the past, according to Schroeder, benchmarking evolved from price-weighting to market-cap weighting to alternative/ equal weighting.

“While market-cap weighting can be very concentrated at times, equal weighting is an extreme solution to this problem and comes with a range of issues on its own,” he said.

“We developed Target Diversification to be a more nuanced weighting scheme that allows you to measure and target diversification directly and strike a balance between marketcap and equal weighting.

“It offers lower tracking error, lower style exposures and higher liquidity than equal weighting, and greater diversification compared to market cap weighting.

The index provider has released a recent paper addressing the subject of diversification:  Worried about concentration risk? Now you can dial up diversification with precision | LSEG.

Macro environment

Schroeder noted that the current macro environment is “a clear cut from the past 25 years in so many aspects such as geo-politics, demographics, inflation and adoption of AI”.

“Strategies that build purely on back-testing over the last 25 years will have issues performing in a very different environment,” he said.

Another recent research paper from FTSE Russell showcases the work done by the research team on balanced macro allocations (Reimagining asset allocation: A balanced macro approach | LSEG). Schroeder notes that for the best part of the last 25 years, the 60/40 stock-bond split was considered the best allocation methodology.

“The period saw healthy returns from both equities and bonds in isolation, and just as importantly, experienced the desired diversification benefit due to their negative correlation,” he said. “However, our analysis of the last 100 years suggests that the last 25 years were an exception rather than the rule.”

The FTSE Russell research found that growth and inflation are key risk drivers of asset returns, and their relative dominance in the market has a direct impact on asset correlations.

Consequently, according to Schroeder, the dominance of growth as the macro risk factor and subdued inflation over the last 25 years manifested themselves in a negative correlation between stocks and bonds and resulted in the outperformance of the 60/40 allocation.

“For the most part of the previous century, however, inflation was more dominant, resulting in a positive correlation between stocks and bonds and triggering a suboptimal outcome of the 60/40 allocation,” he said.

The post-Covid inflation shock and the subsequent sell-off of both stocks and bonds is the most recent illustration of that dynamic, added Schroeder.

“Going forward, deglobalisation, high public debt, demographic changes and slower energy transition all hint towards a more dominant inflation,” he said. “Therefore, we set out to build a balanced macro allocation insulated from both growth and inflation shocks.

“To that end, we included inflation protected assets such as commodities, precious metals and inflation linked bonds in our arsenal, carefully investigated their sensitivities to the macro risk factors and designed an allocation framework which goes beyond the goldilocks of the 60/40 allocation of the past 25 years.”

Transparency, disclosure

Looking at consideration about complexity and risk when it comes to custom & strategy underlyings, Flinois agrees that complex calculations and content create various risks for an index sponsor and the distributor/bank.

“There is a risk that the index construction or the risk embedded in the index are not fully understood by the end client (potentially retail client) and that is why we work closely with our clients and the relevant regulators on disclosure, transparency and robustness of calculations,” he said.

However, it is difficult to avoid complexity as this is also driven by the availability of more datasets, contents, capabilities currently being developed that can be factored into customized solutions.

_{Image: Peshkova/Adobe Stock}

This article is an abstract from the ‘SRP Index Report 2025: Custom & Strategy Indices’, which can be downloaded here.

---

Do you have a confidential story, tip or comment you’d like to share? Contact Us | SRP (structuredretailproducts.com)