S&P launches indexes to measure risk premiums between asset classes

Standard & Poor's (S&P) has created a series of indexes that will make the risk premiums that exist between different asset classes in the US directly investable for the first time.

The indexes track take a pair of sub-indexes and are calculated by going long one index and short the other. For example, the Equity Risk Premium measures the spread of US equities over the returns of long-term government bonds by going long the S&P 500 Futures Excess Return Index and short the S&P 30-Year US Treasury Bond Futures Excess Return Index.

"Asset class risk premiums are a central premise of financial markets but typically cannot be accessed directly. An example is equity risk premiums; the additional return an investor requires to compensate for the additional risk of investing in equities instead of bonds," asks Steve Goldin, vice-president of strategy indexes at S&P in London.

"While the concept exists, getting exposure to it directly does not. We created a set of indexes that provides transparent access to risk premiums to help investors get direct exposure or use the indexes for measuring their portfolio's sensitivities to such factors as the equity risk premium over bonds or oil risk premium over equities."

The other three indexes are the non-US dollar equity, which measures the spread of the return of US stocks over the return of the US dollar index; the crude oil-US equity spread, and the gold-US equity spread.

The ability to measure these risk premiums is unique to the US market, as commodities such as oil and gold are priced in US dollars. They would not translate to other markets, as currency risk and different trading times would be added into the equation.

The indexes launched last week and there has already been a lot of interest from providers wanting to base products on the indexes, including structured products, says Goldin. Factor Advisors, a US investment management company, has made a filing with the Securities and Exchange Commission to issue leveraged and inverse funds based on the indexes.

S&P is looking to create further indexes in the series, and although product launches will initially be in the US, there has also been interest from European investment banks.