Managing Director and Senior Portfolio Manager at Neuberger Berman. So in terms of the format of today's webinar, I'm gonna kick it off with a very brief intro, then turn over to Dinank, who's gonna talk more about how these new index options fit into the existing MSCI ecosystem, as well as the liquidity and volume trends that we see in the existing products. And he'll also do a deep dive into some of the use cases, particularly focusing on how the new index options could help global equity portfolio managers more effectively hedge their portfolio.
Then I'm gonna turn it over to Derek, who's gonna bring his wealth of experience on the buy side and talk about some of the institutional use cases that he sees for these MSCI products, his experience trading them, as well as, you know, how he plans on using or sees using the new index option. So before I get started, a couple of housekeeping items. So we're gonna hold, as usual, we're gonna hold questions to the end, but you can actually submit questions at any point, during the presentation by hitting the Q&A button at the bottom of your Zoom toolbar. We're gonna leave hopefully about five minutes for Q&A, and we encourage you to ask questions. If for whatever reason we don't get through all the questions, happy to follow up one-on-one after the webinar as well. Great.
So without further ado, let me get started by sharing my screen. Hopefully, everyone can see it. So yeah. So what I'm gonna talk very briefly on is our newly launched MSCI Toolkit website. It is, I think, a great resource and a great hub for anyone who's interested in learning more about the MSCI suite of global index options, and a huge, huge shout-out to our Cboe marketing team for putting this together. What I have shown here is just a brief snapshot of part of the website. This, I think, is actually a great summary table of the products that are currently out, the current tradable products out there. So we have the two existing index options, obviously, on MSCI EAFE Index, ticker MXEA, as well as the MSCI Emerging Markets Index, ticker MXEF.
Those have been out for a while now, but you'll also see in the blue highlighted are the three new index products. So MXACW, which is the MSCI ACWI Index, MXWLD, which is the MSCI World Index, and then last but not least, MXUSA, which is the MSCI USA Index. And this summary table just kind of shows you at a glance, you know, how many markets each index covers, the split between developed versus emerging, you know, the notional size, as well as a link to the contract specs if you want to learn more. Again, this is just a kind of partial snapshot of the website itself. On the website, you'll actually find a lot more information.
For example, we have a page that kind of compares the index options versus their equivalent ETFs, if you want to learn more about the differences between the two. We actually have, you know, a couple of use cases, white papers, published research and commentary from both Cboe and MSCI, all linked on the website, so I highly encourage everyone to go check it out. I put the link down at the bottom of the screen, but if you just Google Cboe MSCI Toolkit, it should be the top link. So, and again, you know, thanks to our marketing team for putting this together. The other thing maybe I'll just highlight in terms of the notional size, and this is something that we did in response to customer demand.
As you'll see, you know, the notional size for the MSCI EAFE Index is actually quite large, and that's something that we've heard in terms of feedback from customers over the years, that the large notional size sometimes, you know, makes trading a little bit clunky or like, you know, it's, it's harder for retail clients, RIA community, to really incorporate these products into their portfolio. So when designing the MSCI World and MSCI USA indices this time, the option we actually reduced the notional size. So the notional size on the options are 1/100th of the actual underlying index. So they are smaller notional size to make them more flexible, more dynamic for investors in terms of being able to incorporate it into their portfolio.
In addition to these five tradable products that are currently out there, so three that just launched last week and two that have been out for years, we also recently launched two volatility indices. These are not tradable. So I think these are great tools to help investors monitor volatility of different regions. You know, as we know, VIX, kind of the benchmark for measuring kind of volatility for U.S. equities, and these are meant to be kind of the equivalent for international markets. So VXMXEA is the volatility index for the MSCI EAFE Index, and then VXMXEF is the volatility index for the MSCI Emerging Markets Index. And both of these are constructed in a very similar way to the VIX. They are measures of 30-day implied volatility for the underlying indices.
What I've just shown here on the first chart on this slide is just the index values, so the volatility of the two different markets. The emerging market is in gray, and then EAFE is in the dark blue. And you can see in terms of trend, very similar to the VIX. We've seen kind of volatility come in very dramatically, kind of over the past year across all these different regions, and volatility is currently at or near one-year lows across the board for all of these different markets. And then the second chart I have here, and this is something that, you know, now that we have these different volatility gauges, we can also track, which is the relative volatility differences, right? The RV spreads between the region.
So what I've shown here is just the relative volatility versus the U.S., specifically versus the VIX, to look at the difference in volatility between the different regions. In the blue, that's showing you the difference between EM versus SPX volatility, and then the gray is the EAFE versus SPX volatility. And again, similar trend, we have seen a narrowing of the volatility premium, I would say most pronounced or most dramatic in emerging markets. Actually, we highlighted this at the beginning of the year. EM vol was particularly rich relative to developed, because of the ongoing kind of sell-off stress in the Chinese market. But since then, with the stabilization of Chinese equities, we have seen that volatility premium shrink, quite significantly, which you can see in this chart here.
So that's what I'm just gonna stop here, and turn it over to Dinank, who's gonna talk more about the new index options that just launched, and how those indices kind of fit into the existing MSCI, you know, ecosystem. So Dinank, you know, yeah, please take it away, and let us know, you know, how the, how the kind of the entire MSCI ecosystem all fits together.
Sure. Thanks. Thanks, Mandy, for having MSCI on this webinar and everyone for joining. Before seeing how these products fit in the overall MSCI indexes universe, I shall briefly describe the general MSCI approach for market cap indexes, which is now visible on the screen. This is a rule-based, transparent methodology with the aim to cover the full opportunity set across markets, including developed, emerging, and frontier markets, and can be used as building blocks for portfolio construction by both active as well as indexed investors. Exhibit on the right side shows the ACWI IMI universe, which covers 99% of the global equity investment opportunity set with over 9,000 constituents. This includes indexes or equity universes for developed markets, which is represented by World IMI Index, as well as emerging markets, which is represented by the EM IMI Index.
As shown in the exhibit, these indices cover markets across regions, namely Americas, Europe, Middle East, as well as Asia Pacific. One main point to highlight is the IMI indices include large-cap, mid-cap, as well as small-cap stocks. Now, if we move to the next slide, here, we see we decode the MSCI ACWI Index. Yeah. So yeah, these are the standard indices. That is, they cover 85% of the investable equity opportunity set and include large- and mid-cap stocks only. This slide also highlights the options that Mandy had mentioned at the start of the webinar. Starting with MSCI ACWI Index, this represents constituents from 23 developed markets and 24 emerging markets, so in total, 47 countries.
There is World on the left side, which is 23 countries having close to 1,480 constituents, which is further split into USA, 600+ constituents, and EAFE, 21 countries, 782 constituents. The only missing part in the developed market side is the Canada, where we currently do not have any options. On the right side, there is EM index, where we already had existing options, which is, which represents 24 countries and has 1,440 constituents as of February last month.
Great, thanks, for that. Could you briefly kind of talk us through some of the liquidity and volume trends that you see in the existing products?
Sure. If we look at the next slide, index options are a very valuable tool for investors, and that can be used for different purposes: hedging, leverage, enhanced income, downside protection as well. Following the growth that MSCI saw in the futures, we partnered with global exchanges to grow liquidity across a variety of index exposures so the investors can effectively deploy option strategies within their portfolios. On the right side, we see the plot, which shows the EAFE and EM index liquidity-linked options liquidity for the past seven, eight years, which has consistently grown just to provide... And this includes just the EAFE and EM index linked options listed across all exchanges globally. Just to highlight one metric, for the past year, 2023, there were 2 million contracts that were traded in total for these two indexes.
Just to provide some additional perspective on the next slide, we also highlight the futures liquidity for the similar universes, where we show the trends in the volume, volume notional across the contracts, across exchanges for the last five years, clearly showing that EM and EAFE have been the dominant ones.
Got it. Great. Yeah, and I see that, you know, even though, you know, the World Index options obviously have just launched, there is actually quite a bit of liquidity and volume already in the MSCI World futures.
Yeah.
Great. Then maybe, like, the next question I have for you, just talk us through some of the use cases that you see for these index options, and maybe do a deep dive into... I think hedging has been one that comes up, you know, time and time again for a lot of investors, so how they can more effectively use these MSCI options, index options to hedge their global portfolio.
Sure. So on slide currently visible, we see that derivatives in the overall investment process have a very crucial role to play, and this slide highlights some of them. These could be for benchmark replication, exposure management, which is around implementation of hedging strategies, completion overlays, which is to align the plan exposure with targets, and could be tail risk hedging, which is mitigating the large expected drawdowns. These specifically focus on one case study. In the next slide, where, which is based on MSCI World Index replication, which is a multi-country, multi-currency contract. There are a variety of potential methods when investors seek to replicate the global or regional index using index options, depending on the liquidity, transaction cost, which in this case could be premiums, and tracking error consideration.
Some may choose to match the options with the index they choose to use to measure the performance, while others could turn to local index, not directly linked to the index, whose performance is sought to be replicated and combine it with currency forwards. In this case, we assume two hedging indexes. These are simulated indexes. What we see is there is Hedging Index A, which we construct, which is based on the top regional/country exposures of MSCI World. So in Hedging Index A, we are combining USA, EMU Top 50, which is European Monetary Union Top 50 Index, Japan and U.K. And in Hedging Index B, we just take two universes, which is USA and EAFE.
And we try to simulate this by seeing that, okay, these are the selection of indexes taken from based the largest geographical exposures, and we wanted to minimize the number of indexes, because at the end, those will be the consideration for investors. And to assign the weights to these indexes in this simulation, we ran an optimization that minimized the tracking error for the indexes. If you move to the next slide, we use MSCI analytics to look at how the risk looks like for these hedging strategies. Clearly, the blue bar, which is Hedging Index A, based on single countries and regions, is higher than the red bar, Hedging Index B. This shows that there will be higher tracking errors or higher risks that the investor would be incurring, even if they are not completely adhering to their benchmark.
The country risk and currency risk also get elevated when you use World Hedging Index A as compared to World Hedging Index B. So this was the equity part. In the next slide, we present three scenarios, which could be because if you are using local index options, you could be exposed to currency exposures as well, and those are additional risks. So in the first case we have, in which equity option and the currency denomination is index aligned. This is a perfect scenario. For example, you do not need an additional exposure for a USD investor who is using USD-denominated options linked to MSCI World Index. In the second scenario, equity option is index aligned, but the currency is not. In this case, a currency forward may be needed to match the exposures.
In the last case, when the equity option is not index aligned, you would need a combination of regional and country index options, as well as non-currency based forwards, based on the currency exposures of the index. So just to summarize, we just showed that if you try to replicate or hedge using a basket of local index options instead of multi-country, multi-currency contracts such as World, it could be even ACWI, EAFE and EM. Such contracts, you incur a higher tracking error, which could be further amplified if there is higher currency volatility as well as lower regional or country correlations. So multi-country and multi-currency options help capture the index exposure in a single contract with less tracking error than a partial replication or partial hedging.
Great, thanks, Dinank. If we go back to the previous slide, I think if there was an option C, which is just using MSCI World Index options, which obviously just launched, you know-
Yeah.
that would minimize, obviously.
Yeah.
-you know, tracking risk even more, especially for a U.S.-based, like you said, a U.S.-based investor, right? Because then they also-
Yeah.
-don't need the currency, hedging component. Great, thanks so much. Okay, so now I'm gonna turn it over. I'm gonna show the obligatory, disclaimer slide, and then I'm gonna turn it over to Derek. So let me... Okay, perfect. So Derek, before I, you know, ask you to talk more about the MSCI products, could you just give a quick intro in terms of kind of your role, and the strategies that you look after at, at Neuberger Berman?
Absolutely. Thanks, Mandy, and thanks, everybody. Yeah, so I run an index option group. We've been at Neuberger about eight years now. We've been running the strategies north of $5 billion in index option strategies for going on 14 years. So we're, we're excited for the, the new product offering. I think the evolution of, the index option space over the last decade or so is really what I consider the democratization of volatility. I mean, for everyone to think about it as a volatility or as an asset class that people have been talking about for, for decades at this point, is really starting to, I think, happen. It needed more tools, it needs things like this. So we're, we're excited. We've used the emerging markets in the EAFE since they launched.
We're kind of big adopters, had some unique clients with some, I'd say, unique needs. Every client has unique needs, but so we were early adopters there, having run global index strategies using ETFs and things prior. But again, I liken this a lot to high yield thirty, forty years ago. These new issues come out, people realize you can trade them, people are able to hedge new vectors, do new solutions, and take it more into an institutional class. And then also, I think, one off the top of my head, it's great, even just the contract size, being thoughtful there, being understanding that, you know, options are for all now, not just for the heavyweights. So yeah, so we've been doing it. We're excited. Let me pause there.
I can kind of go through some of our additional thoughts, but let me maybe stay focused.
No, that was great. Yeah, so I think the first question to you is just, you know, can you walk us through some of the main institutional use cases that you see for the MSCI index options, both the new as well as the existing? You mentioned you've been trading the EM and the EAFE options, you know, from the beginning. How have those use cases maybe evolved over the years? Just kind of your thoughts... there?
Yeah, you know, again, kind of going back to the theme of, of democratization of volatility, in our mind, it's really the solution set. If you think about the S&P 500, and it's great, I mean, we use, I mean, $6 trillion in open interest, seems to grow every year. People find new things, zero days to expiration. I mean, just. But it's been the only game in town for a reason, because there really hasn't been, you know, the global solution. And the EFA and Emerging are great, but what happened, in my opinion, is they're very focused, right? You have to have an emerging market allocation. Then to get into emerging market options, you have-- other than hedging. So baseline, everybody always thinks of options as hedging. Oh, I got to hedge myself. I got to control risk in some cost manner.
So there was really no motivation other than specific strategies that we can get into. But, you know, the breadth of what you're gonna do with just an emerging market index option is only gonna go so far until you had what I consider the top level. So now, when you have the world or the ACWI, you're really into the space of, "Hey, maybe I should hedge my whole portfolio rather than just beta adjust something to the S&P." Because, again, the working model is that it's a wholesale market for risk. You used to have to go to banks, you used to have to go to others to lay off the risk. They would manufacture products to kind of control the risk, structured notes, you know, all sorts of things, hedging programs, systematic strategies, risk premia.
You know, you go down the list, and now, all of a sudden, you have something that, as was illustrated, has, it actually matches the tracking error. You can actually put it in an institutional portfolio and not have the basis risk swamp some of the other merits, right? We've done a lot of analysis over the years where we're like, "Hey, this looks great," but then the basis risk alone makes it unappetizing for something that's looking for, you know, a couple hundred basis points of tracking error or less. So, so again, I, I think when you start to talk about opening up world markets and hedging, that's kind of the baseline. Then you go into, you know, all the macro strategies and future strategies that have become so popular. CTAs, well, CTAs and futures markets are just the other half of the option market.
So now you're going to have both, and that lets volatility, again, be much more of a asset or a strategy as opposed to just a tool. So that's what we work with clients a lot, that whether you're going on offense or defense, whether you want to be global, you can think globally now without having to trade multiple, you know. Just kind of like as you roll single names up into indexes. We love indexes. We don't like single names. Single names are idiosyncratic. You need research. You might as well be a long-only buy-side stock research, like we have here at Neuberger, to try to and then price individual options. Those are for the big banks to trade and hedge funds do arbitrage trades with. But when it comes to wholesale institutional risk and carry trades and just go down the list.
So that's, that's why we're excited that you, you now have something that, you know, competes, I think, with the S&P globally, because everybody's gonna think globally. I mean, the S&P has dominated the market for 20 years because it's the only thing that goes up all the time. I don't know that that's the case for the next 20 years. But again, let's not get into market views, and let me kick it back to you.
No, I think that's, that, that's great, and I think one of the use cases that, you know, we certainly heard from a lot of investors, A, it kind of touches upon, you know, the diversification kind of theme that you've already brought out, like, you know, S&P to diversify away, whether you're looking at hedging programs or yield harvesting programs. And the second is, especially at this juncture, right, like that, the tactical views around, you know, how long can this U.S. outperformance last? How can I play this tactical, maybe, like, developed over U.S. views? Well, now we have a complete set of, you know, global indices, as we talked about, that people can, you know, express those views.
Yeah. And I would throw in there, one thing that I'm also a big supporter of, it's gonna make the option markets that much more liquid, right? When you give the trading houses and you give the brokers and- not brokers, but the banks and everybody, the big, big desks, you know, different... I mean, because hedging the Greeks in options has always been a really big challenge because you can only do so much, and that's why, like, zero days to expiration options are kind of cool for traders, because now they have basically daily liquidity with end-of-day expirations to control their second order risk.
Now, when you talk about hedging global equities or wanting to create those hedges or the carry trades or what have you, the liquidity should get better because you now have kind of the big ACWI's and the big world's, so that you can have that volatility as well as just the S&P or the EAFE or the emerging. So that, I also think it just facilitates a much healthier and probably more stable, even trading environment and volatility over time, which, again, I think bodes well.
Great. So we talked about minimizing tracking error, which is obviously a big pro in terms of using these, you know, multi-multi, country, multicurrency indices, as Dinank mentioned. One of the drawbacks or one of the things that people always bring up is liquidity, right? So I wanted to ask you about kind of what has been your experience trading, you know, the MSCI index option?
Yeah, it's been really good. I mean, every time, I mean, barring some de minimis size, we've been fortunate enough, we haven't done this, you know, tried to squeak this into small portfolios, but and we've always been well inside bid-ask and close to mid. I think the markets are wide for kind of conservative and, you know, any new product, they have to make sure they make some money or at least don't get, you know, whipsawed or what have you, or taken advantage of. So the spreads always looked wide in the early days, but the liquidity is definitely there. I mean, as long as the futures trade well, there's really we've never had a problem getting a trade done. We've never had partial fills. Just true to, and pretty much any of the big index options or even the big ETF options.
And secondly, look, not to get too far in the weeds, I mean, there's a lot of volume that goes through the iShares ETFs with very similar risk profiles. Wholesale risk markets are gonna love this idea that they're selling and buying and trading in the index options space, just like they do with the S&P, and then get to lay that risk off or manufacture more risk, i.e., more revenue and profit for their desks by trading SPYs and ACWI and things like that. So again, that ecosystem is not just like looking at a stock and saying, "Oh, this bond doesn't trade.
Oh, I'm sorry, this stock, these, these spreads are too wide." No, they're just wide because the market maker needs to be careful, but then when you go to market, there we've never had a problem with the EFA or the emerging market ones over the last, I can't even... I'm gonna say it's been at least 5 years, but time flies anymore. So this last three to five years, I mean, we've traded $ billions in that space, and have even the impact costs. I mean, we have to report to some of our clients, and when we look at, you know, we're very close to mid, if we use mid as our boat, if not better sometimes.
A lot of bad situations, we've been through many and much better on the selling side in certain days when markets kind of get a little nervous. So, but let me pause there because I want to leave time for the question stuff. But yeah, if anybody has any further questions on liquidity, I only expect it to be better in the bigger, more diversified index than like emerging markets. It has been very liquid, and you would think relative to other emerging market assets, that's not been the case, but in volatility, it is.
That's great to hear. So yeah, let me turn over to Q&A, and we already have a couple of questions in the queue. One question, and turn this over to you, Derek, first. Just how are you planning on using the new options, whether it's ACWI, World, or USA, in your portfolio?
Yeah, you know, right off the top, it's... I mean, we're not a big relative vol or arbitrage. I mean, we're buy side, but either just looking at two things: one, the relative volatility of it as a hedge versus some of the constituent indexes, I think is a pretty interesting idea. So we'll look at that right off the bat, just because we've seen, you know, volatility characteristics, again, in single name arm is very idiosyncratic. You can't control it. But when you look at some of the currency, as it was highlighted, the currency risk is in these, which is really efficient and good for us as well. So you get, again, that relative vol, as well as just the hedging solutions we haven't had before. It's pretty expensive to hedge emerging markets with emerging markets.
So over time, I think there's just... Basically, the vanilla strategies that you haven't been able to do will have some unique elements because these are rolled up big global indexes that now you can get a price for the risk on and volatility, and I'm expecting it to, at times, dislocate and at times to be even cheaper, given the diversification embedded in them to probably carry volatility long versus being short some of the constituents. So those are the two big things, the hedging, plain vanilla stuff, but then I do think the index vol arm gets a little more interesting.
Great. All right, so the next question, I'm gonna turn over to Dinank, and just question around the trend of short-dated option trading. We have obviously, obviously seen that kind of explode in, in, you know, S&P and some of the other indices. What do you see in the MSCI index options space?
Sure. So I think if we talk about the two main, like, EFA and EM options, which have been live for some time, overall, the trends within the two also have been quite dissimilar. For EFA, just to give a pretty similar look, similarly to what we see in other U.S.-based contracts, we see currently the maturity of less than one month, if we categorize that as short-dated, now constitute around 65%-70% of the option volume, and this has risen from 40%, it was pre-COVID, 2019. Whereas for EM, this number is close to... It has been in the range of 40%-50% for the past four or five years. Again, the distinguishing factor being that these two contracts are listed globally on multiple exchanges. That's why the short-dated one is primarily the U.S. thing.
I think other exchanges are still coming up with that.
Got it. Okay, and then one question, I think this is kind of interesting, is just why did you guys launch EFA and EM first before World and then ACWI?
Yeah, so I think which options to launch, I think, depends on multiple factors. It could be AUM benchmark and also how the traction investors have already shown for other derivative products, maybe futures on ETFs. I think one of the slides that we showed, that was a prime example that why EM and EFA were more prominent. I think the futures liquidity that we have seen, EM and EFA are the most dominant contracts. That's why that becomes a much more go-to contract, and then this will be followed by other universes, ACWI, World, and USA.
Okay, perfect. So we are currently exactly at time in terms of, you know, being, this being at 9:00 A.M. We do have a couple more questions. A lot of the housekeeping questions, just in terms of, you know, will the slides be available, and replays be available? The answer to both is yes. We will send them out. Usually, it takes a couple of days to put the replays together, but, you know, sometime next week, you should be, getting an email. Everyone who registered for the webinar should be getting an email with the replay as well as a copy of the slide. So, if we didn't get to your question, you know, feel free to follow up with us, you know, individually or, you know, after the webinar.
Thanks again to everyone for joining today's webinar. And especially thank you to our speakers, Derek and Dinank.
Thanks, Mandy. Thanks, everyone.