Indexology^® Blog

If you believe the S&P 500, which is market cap weighted, is considered the U.S. stock market beta, then the S&P GSCI, which is world-production weighted (analogous to market cap weighted), is the logical choice for commodity beta.  Typically, using an index, namely the S&P 500, as the benchmark for beta is standard practice in trying to describe the behavior of a single stock compared to the market. For example, a healthcare company, say WellPoint WLP, has a beta of .61, and a technology company, say Facebook FB, has a beta of 1.9 (according to Yahoo Finance).  What this means is that when the stock market index moves, WLP moves less than the market and FB moves more than the market.

In general, the following rules apply:http://en.wikipedia.org/wiki/Beta_(finance)

While we know generally tech stocks have higher beta than healthcare stocks, not many study the beta of commodity sectors and singles.  When examining monthly returns from Aug 2002 – Aug 2013, as one might expect, the beta of the energy sector is greater than 1.0 at 1.25. A less expected observation is that the beta of silver and nickel equal each other at 0.59, yet gold’s beta is only 0.27.  Not only were the betas of nickel and silver the same but surprisingly relatively high (ranked 8 and 9 of 24) for the very low weights in the index, only about 40 basis points each.  Another surprise was that natural gas, despite its low weight in the S&P GSCI of about 2.5%, had a beta greater than 1.0 of 1.1, and also no single commodity outside of energy had a beta greater than 1.0.  

While the S&P GSCI may be the best representation of the commodity futures landscape by its world-production weight, when investors measure beta of a single commodity or sector, they may use the Dow Jones-UBS Commodity Index, also a market leading benchmark. The DJ-UBS CI does use liquidity and production in its weighting scheme; however, it imposes limits on single commodities, groups and sectors since diversification is one of its key principles of construction. Learn more about the differences between the S&P GSCI and DJ-UBS CI.  

Using the DJ-UBS CI as a benchmark, it was no surprise the beta of energy was a bit higher at 1.39 than for the S&P GSCI at 1.25 since energy comprises more of the latter index. What was less expected was despite the relatively equal weights of commodities in the DJ-UBS CI as compared to the S&P GSCI, only 4 of 17 commodities outside of energy had a beta of greater than 1.0. Copper, Silver, Nickel and Corn had respective betas of 1.14, 1.14, 1.10 and 1.01. The other surprise was despite a high weight of almost 10% in the DJ-UBS CI, gold only had a beta of 0.55.

Please see the table below for the betas of commodity sectors and singles.

Source: S&P Dow Jones Indices. Data from Aug 2002 to Aug 2013. Past performance is not an indication of future results. This chart reflects hypothetical historical performance. Please see the Performance Disclosure at the end of this document for more information regarding the inherent limitations associated with backtested performance

The S&P Municipal Bond Puerto Rico Index ended September 10, 2013 down 19.14% total return year to date which was up slightly from the previous day.  Its too early to tell if  these bonds have hit bottom.  Puerto Rico municipal bonds have been weighing on the muni market since mid July.

Join S&P Dow Jones Indices for a free forum on the municipal bond on October 17th in NYC.  The event will be live streamed as well.   http://www.spindices.com/sp-events/municipal-bond-event-from-stable-to-challenging

This morning (September 10^th) S&P Dow Jones Indices announced three deletions and additions for the Dow Jones Industrial Average.  This post explains why we made these changes. The press release is on www.spdji.com

The Dow is price weighted – each stock’s weight is the ratio of its price to the total of the prices of all 30 stocks.   When the largest stock price is about 185 and the sum of all 30 prices is about 1943, an eight dollar stock has little impact – a weight of about 0.4% (or 40 basis points).  The three stocks being dropped together represent about 3% weight in the index.  At the same time, the high price stocks have a disproportionately large impact on the index. The highest price stock at about 185 has a weight of about 9.5%.   After the changes the highest weight stock is lower at 8% and the lowest rate is more than doubled at 1%.  The improved weighting means that we are not wasting one or two of the thirty names on stocks with minimal weight.

The changes also improve the sector representation. Adding Nike provides more exposure to consumer discretionary stocks and introduces apparel and footwear as well. BankAmerica and JP Morgan Chase are quite similar to one-another; replacing BankAmerica with Goldman Sachs gives some diversity to the financial sector.  Likewise, Visa adds diversity to the tech sector compared to Hewlett Packard.  Hewlett Packard’s businesses are close to those of other tech companies in the Dow while Visa is a leading payment network operator, an activity not as well represented by other Dow stocks.

Changes to the Dow always bring a lot of questions from the media and investors. Three asked today:

The most asked question of the day was probably “why not Google?”  The answer is price weighting – Had we added Google and dropped some high priced stock; Google would have dominated the index with a weight of 25%-30%.  Google may be important, but we shouldn’t pretend it is a quarter to a third of the whole market.

Close behind Google is whether we thought about changing to a different weighting method.  We think about, and discuss, a lot of things with indices. The Averages Committee, which is responsible for the Dow, the Dow Transports and Dow Utilities, will review some recent work on how indices are weighted.  Whether any changes will be made is a question for the future – wait and see.

Do additions or deletions say anything about the companies?  First, additions or deletions to the Dow or other indices are NOT investment recommendations.  Second, the goals in these changes to the Dow were to improve the sector balance and improve the weighting, not to pick stocks.

Everyone wants to invest with the ‘smartest guys in the room’. But what do the smartest guys invest in? Well, a poll of mutual fund professionals suggests a very surprising result.

As regular readers of this blog will know, while there are plenty of managers who can show attractive returns over the past few quarters it is statistically almost impossible to find managers that can deliver better-than benchmark returns persistently over longer time periods.

But we’re not the only voice in this argument. An entire industry of active fund managers are gainfully and necessarily employed in the cut-and-thrust of this debate. That’s why I was fascinated to come across this article. In summary: 77% of mutual fund professionals are moderately or significantly invested via passive investment products. So perhaps they too see the value of index investing, at least for a portion of their personal account.

It’s always pleasing when we see evidence that our data are being used to help inform investment decisions, so I hope you’ll join me in applauding the investment acumen of active managers who invest passively. They might appreciate the irony.

The idea of “smart beta” is gaining increased acceptance, although not without some controversy.  I have to confess that I really dislike the term “smart beta,” and not just because I didn’t invent it.  “Alternative beta” I can live with, or “factor” indices, or “strategy” indices — but “smart” beta leaves me cold.

Which is not to say that I dislike the concept.  Unlike more venerable capitalization-weighted indices, factor indices are designed to produce a particular pattern of returns, or to exploit a putative inefficiency in securities pricing.  For example: the S&P 500 Low Volatility Index extracts the least volatile members of the S&P 500; it aims to produce a pattern of returns less volatile than that of the parent index, and to exploit the so-called low volatility anomaly.  Like most factor indices, S&P 500 Low Vol is not capitalization-weighted (each component’s weight in the index is in inverse proportion to its volatility).  For investors who find a less-volatile pattern of returns congenial, Low Vol can be a very “smart” strategy.

So why do I object to the “smart beta” label?  “Smart beta” suggests that traditional cap-weighted indices are somehow less than fully smart.  That may be a clever marketing hook, but it misstates the investment merits.  Most active managers underperform cap-weighted indices most of the time.  That means that one of the smartest things an investor can do is to use cap-weighted indices as the core of his portfolio.