SPA Conference: Risk-control indexing scales volatility down, reduces cost of options

By Emma Trincal

New York, Nov. 13 - Risk-control indexes give investors the option to control volatility by selecting a certain volatility target level while gaining exposure to any of the markets covered by S&P Down Jones indexes, said Vinit Srivastava, vice president of strategy indexes at S&P Dow Jones Indices. He was making a presentation at a special panel on risk control at the 9th Structured Investments Autumn-Expo 2013 Distribution Conference.

For structured notes issuers, the use of those indexes offers customization and cost efficiency with pricing, he said.

"A risk-control strategy will target a certain level of volatility," Srivastava said.

"It's simply a transparent overlay that sits on top of an equity or commodity index and is designed to target a certain volatility level."

Those indexes may benefit issuers and investors alike as they are "highly configurable," he explained.

"You can configure your own index, the calculation of the volatility, the interest rates that reflects the cost of borrowing. The parameters also include the type of rebalancing that you want."

Outperformance

The idea behind those indexes, which have been used as the underliers of structured notes, is to reduce high levels of volatility in some strategies or markets and to enhance performance.

"The risk-control version of the S&P 500 has outperformed the S&P 500 on a risk-adjusted basis over five- and 10-year spans," he said.

Investors can get exposure to more volatile indexes, such as the S&P BRIC 40 index, and scale back the volatility at the desired level, he said. The type of index used will tend to determine the volatility target, he said.

"What's the most popular has been a 10% volatility target, but that's for the S&P 500," he said. "For the BRIC 40, we tend to see a volatility level of 18%."

Transparency

The transparent algorithm overlay used for the construction of the indexes gives investors the advantage of controlling risk at a predefined level of historical volatility, he said.

For the issuers using those indexes as the underlying of a structured product, cost efficiency is one advantage, given the high level of configurability of the parameters, he said.

"It allows you to price options more effectively," he said.

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