Indexology^® Blog

On June 3, 2015, the PBoC announced the opening of the China onshore repo market; the offshore RMB-clearing and participating banks will be allowed to trade bonds on repos in the onshore interbank bond market.  This is an important development for the offshore RMB market, as it will broaden the offshore RMB supply and support further RMB capital account reform.

By connecting the onshore and offshore money markets, the difference in interest rates between the two markets is expected to narrow.  In fact, if we look at the yield performance of the offshore market, represented by the S&P/DB ORBIT Index, and the onshore market, represented by the S&P China Bond Index, we see that the spread has significantly reduced from 206 bps in early 2014 to 17 bps as of June 3, 2015.  The offshore yield has traded above the onshore yield since 2014, on the back of the weakening currency and tightening liquidity in the offshore market.  Beyond the convergence, their responses to market conditions have also become more in-sync, particularly during the recent rate cut.  It is interesting to note that the correlation between the two yield performances was -0.8 in 2014, whereas in 2015 YTD, it rose to 0.8; this implies that the two markets may be becoming more correlated.

Nevertheless, some differences remain. For example, in the perspective of monetary policy and liquidity, the onshore and offshore RMB money markets have different market dynamics. Additionally, in terms of market structure, some of the issuers in the offshore market are foreign names and a portion of the offshore RMB bonds received international bond-level ratings, whereas the onshore market is dominated by domestic issuers, and they are rated by local ratings agencies only.

Please see the yield chart in Exhibit 1 and index performance in Exhibit 2.

Investors have spoken: There is a world outside of traditional indexing, and they want in.

“Smart beta” or factor indices bridge the gap between active and passive management by allowing investors to tilt toward specific investment attributes – for example, low volatility or high dividend yield.  These indices use factors in a rules-based, transparent manner to determine index composition and/or weighting. Smart beta products give passive investors access to factor exposures that were once only available through active management.

Smart beta has flourished, attracting more assets than ever before. According to our 2014 Survey of Indexed Assets, AUM in products linked to S&P DJI smart beta indices grew 55% in 2014.  As the demand for factor indices has increased, so too has their availability. We’ve created indices to provide a wide variety of exposures, while still maintaining the advantages of passive management.  The growth of ETFs as a delivery vehicle has complemented the growth of factor indices, enabling investors to seek new opportunities.

That said, demand for smart beta has not been cannibalistic; passive investment in traditional exposures has also increased. AUM growth in products indexed to the S&P 500 outpaced the growth of the index, indicating positive net flows into traditional cap-weighted investments. The demand for first-generation indexed investments has not decreased in the wake of new “smart” offerings.

Much research (including our SPIVA reports) confirms that most active managers underperform most of the time. The probability that an active manager beat his benchmark is low, and the probability that he did it consistently is even lower. Positive inflows into passive vehicles indicate that investors have heeded these data, and that the smarter investor prefers better odds.

European bonds markets had a lot to take in last week.  For the most part, they all responded with a downward price reaction regardless of risk profile, with the exception of Greece.  The ECB left monetary policy unchanged.  Eurozone inflation for May climbed to 0.3%, indicating that QE is having the desired effect.  Greece chose to bundle its June payments to the IMF into one payment scheduled for June 30, 2015, buying them more time to negotiate their debt obligations.  Last, strong employment numbers out of the U.S. pointed to possible Fed rate hikes, which is always a catalyst for a bond market sell-off.

This reaction indicates that, despite continued uncertainty out of Greece, the European bond market is turning away from a “flight to quality” stance.  This could be due to a perception that Greece is on the right track to meet its loan obligations, and/or it could be due to improving economic signs both in Europe and in the U.S.  Spain and Italy, two countries tied to the “risk-on“ trade, also moved down in tandem with the countries associated with the “risk-off”/“flight to quality” trade like Germany.

If we look at data from the close of June 1, 2015, to the close of June 8, 2015, yields on most European government bond markets significantly widened (while bond prices went down).  The S&P Germany Sovereign Bond Index and the S&P Spain Sovereign Bond Index both widened 18 bps, the S&P Italy Sovereign Bond Index widened 16 bps, and the S&P Ireland Sovereign Bond Index widened 24 bps, while the S&P Greece Sovereign Bond Index ended unchanged for this period after tightening 8 bps on Friday.

This is the third blog in a series on the evolution of Australia’s tax-aware investment management (TAIM) landscape.

Large asset owners, including statutory authorities, university endowments, and charitable bodies dominate the Australian investment landscape.  However, the largest asset owners by asset size are the 260-odd superannuation funds who collectively manage some 60% of Australia’s ~AUD 2 trillion pool of retirement savings known as superannuation. Each fund pays tax on taxable contributions made by employers and members, together with income and capital gains earned on investment assets.  Super funds do not, however, pay tax on earnings of assets backing pensions.  In Australia, super funds either pay tax at a notional rate of 15% for working members, or 0% for members in pension mode who are 60 years or older.

What difference do these tax rates have on returns experienced by members? In the case of Australian shares that pay dividends, quite a great deal as the below chart illustrates:

Members in accumulation (working) mode might incur a tax of between 10% and 15%, or receive an uplift of up to 21% on their Australian shares.  Members over age 60 and in pension mode either have no tax effect or receive an uplift of up to 43% on each dollar of fully-franked dividend attributed them.

Given the low rate of tax paid by superannuation funds, their ability since 2000 to recoup excess franking credits, and the large difference in tax effect between working and pension members, one would assume that super trustees would be among the most tax aware of investment fiduciaries.  However, recent history has painted quite a different picture, which will be discussed in the fourth, blog in this series.

To learn more about how to weigh your after-tax benefits, visit www.spdji.com/tax-aware.

In recent years, Chinese authorities have rapidly accelerated the pace of reforms aimed at making mainland-listed A-shares accessible to foreign investors.  Among other developments, the expansion of the Qualified Foreign Institutional Investor (QFII) quota, the introduction and subsequent expansion of the Renminbi Qualified Foreign Institutional Investor (RQFII) quota, and the launch of the Shanghai-Hong Kong Stock Connect Program have combined to significantly increase market accessibility.

As of May 29, 2015, China represented 31% of the S&P Emerging BMI and 3% of the S&P Global BMI.  However, if China A-shares were represented in full, China would command a weight of approximately 60% in the S&P Emerging BMI and 10% in the S&P Global BMI, making it the second-largest country behind the United States, globally.

Given the size and importance of China’s equity market, the relaxation of foreign investment restrictions on A-shares is clearly one of the most important factors currently affecting global benchmark design, and it is top-of-mind among many in the investment community.  Because of this, S&P Dow Jones Indices has closely followed evolving regulations and actively consulted with market participants over the past two years regarding their experiences transacting in the market, in order to best assess the practical impact of the various reforms and any resulting effect on our existing benchmarks.  In addition, the increased accessibility to the market has spurred the need for a variety of new indices demanded by different segments of index users.

In the past few years, the pace of new index development has increased substantially in response to demand from market participants with various levels of interest in and access to A-shares.  In November 2013, SPDJI introduced the S&P Total China BMI, which includes both A-shares and offshore listings for those seeking a comprehensive China benchmark.  Then in November 2014, we introduced a parallel version of the S&P Emerging BMI—named the S&P Emerging BMI + China A—for use by investors who are looking for an emerging markets benchmark that includes A-shares.  Concurrently, we launched a variety of key regional indices, such as the S&P Global BMI + China A and the S&P Asia Pacific Emerging BMI + China A, to cater to asset managers incorporating A-shares into their investment process.

The introduction of the Shanghai-Hong Kong Stock Connect program in November 2014 marked an important breakthrough, as it allowed market participants to access a wide array of Shanghai-listed stocks without having to be approved for QFII or RQFII quotas.  Following the introduction of the Stock Connect Program, S&P DJI introduced the S&P Access China A and the S&P Access China A Dividend Opportunities Index.  Each index is based on the universe of mainland-listed shares accessible through the Stock Connect Program.  All eyes are now focused on the launch of the Shenzhen-Hong Kong Stock Connect, which is expected to launch later this year.

S&P DJI has published a variety of Chinese equity indices since the mid-1990s, beginning with the S&P China BMI, a comprehensive benchmark including offshore listings available to global investors, and the Dow Jones China 88 Index, which includes the largest and most-liquid A-shares.  Over the years, we have substantially increased our suite of Chinese equity indices, as asset managers and other market participants have demanded a variety of different benchmarks for the market.  We will continue to monitor closely the evolution of the A-share market and consult with market participants in order to evaluate any necessary modifications to existing benchmarks and to develop innovative new indices covering the Chinese equity market.