Indexed for growth – The democratisation of thematic indexes

Simon Karaban, head of index services at Singapore Exchange (SGX), talks about environmental, social and governance (ESG) indexes and how the emergence of exchange-traded funds (EFTs) and wealth platforms is democratising thematic indexes, making them more accessible to retail investors

What does SGX offer as a provider of index services?

Simon Karaban, SGX

Simon Karaban: SGX definitely distinguishes itself from traditional benchmark providers in the marketplace. Our iEdge suite of customised and thematic indexes offers technology and an open-source approach to provide more bespoke and flexible solutions. Our index development and production platform offer a unique avenue through which product issuers can innovate and differentiate their products in a trusted and governed fashion.

 

What is the suite of solutions SGX offers?

Simon Karaban: Bespoke solutions comprise a very large portion of our business but, beyond that, we have also focused on developing a broad suite of thematic indexes in collaboration with our research partner FactSet. We develop our solutions for key geographies and key segments in a top-down manner by identifying the high-level trends where specific industries can take advantage of and contribute to the shift in demand for goods and services. Presenting this in an index format allows product issuers to access these segments in a transparent and cost-efficient way.

 

What is driving the interest in thematic indexes?

Simon Karaban: On the one hand, the development of such indexes is becoming increasingly sophisticated as there is better-quality information and technology that allows you to generate more representative thematic portfolios. On the other, you also have more efficient and easier access to themes now through ETFs and different wealth platforms that allow a larger base of investors to participate in emerging themes. Thematic indexes have existed for many years, but have traditionally been restricted to institutional and high-net-worth investors. Now, through the emergence of digital wealth platforms and ETFs, access has become more democratised.

 

How does SGX develop its thematic indexes?

Simon Karaban: We develop a top-down view of the prevalent long-term secular trends across five key areas: technology, sustainability, evolving economies, demography and defensive solutions. We then identify the industries associated with those trends and the revenue attribution to the related industry and geography through the FactSet research tool. Our main goal is to be as representative of any given theme as possible. Too many thematic indexes rely on a catchy name to win attention, but are actually a fairly weak representation of the theme itself. As an additional overlay, we apply a machine learning model in the form of hierarchical clustering to ensure that thematic portfolios are well-aligned and truly representative of their stated objectives.

 

How important are ESG considerations for investors in Asia?

Simon Karaban: ESG is of increasing importance for investors in Asia, and we are seeing a spillover effect from regulation in Europe that mandates ESG transparency and compliance with decarbonisation targets. Within emerging markets in Asia, there is a widely held misconception that ESG is an alpha factor but, in reality, excess returns are driven by quality. While emerging markets can present more macro risk compared with developed markets, there is obviously a more natural flight-to-quality, which is not determined by ESG in isolation. Rather, it is determined by equity risk premium in the form of the quality factor.

 

To what extent is ESG quantifiable?

Simon Karaban: In the form of scores, metrics and signals; however, due to the absence of standardised, generally accepted and approved non-financial reporting standards, these are rooted in very weak foundations. Many of the metrics that institutions depend on today are dated and fail to adequately capture the current culture of sustainability within an organisation. If you look at the metrics produced across all main ESG ratings providers, there is little or no consistency. This is rather distinct to a credit rating, for example, which has a reasonable degree of alignment across the agencies. It is very important that ESG is quantified properly in the context of developing systematic and rules-based index methodologies. Moreover, these ratings are now having an effect on the cost of capital for issuers of both equity and debt, so it’s something that deserves scientific attention.

 

SGX bought a smart beta index provider earlier this year. How does this acquisition add to the platform and what are SGX’s plans going forward?

Simon Karaban: We acquired Scientific Beta, which was named Indexing firm of the year at the Risk Awards in 2019. It brings an academically driven approach to the development of indexes, which marries very well with the flexible, technology-driven solutions at SGX Index Edge. Scientific Beta is already established as a thought-leader in equity risk premia and is now doing a fine job of cutting through the noise in ESG and sustainability, and will no doubt establish itself as a thought-leader in that area as well.

Together, we offer a very powerful proposition in being able to deliver creative and nuanced solutions to clients in a research-driven manner, and we plan to explore further innovations in risk factors, ESG and thematic indexes.

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