Indexology^® Blog

The Dow Jones Sukuk Total Return Index (ex-Reinvestment), which seeks to track USD-denominated, investment-grade sukuk, had a great start in 2017 and rose 1.24% year-to-date (YTD) as of Feb. 10, 2017. A total of 19 sukuk with total outstanding par of USD 15.75 billion were added into the index last year; however, no new sukuk issuances are eligible for inclusion so far this year.

Longer-maturity sukuk continued to outperform among the maturities-based subindices YTD. The Dow Jones Sukuk 7-10 Year Total Return Index rose 2.16% YTD and 6.52% over the one-year period. Similarly, the Dow Jones Sukuk 5-7 Year Total Return Index gained 0.90% YTD and 5.70% over the one-year period. Looking into the historical total return performance, this trend has been consistent in the one-, three-, and five-year timeframes.

Among the ratings-based subindices, the bucket rated ‘BBB’ gained 1.62% YTD, followed by the ‘A’ category, which was up by 1.38% YTD. The biggest exposure in the Dow Jones Sukuk BBB Rated Total Return Index was Indonesia sovereign sukuk, which represents over 40% of the index. The Dow Jones Sukuk AAA Rated Total Return Index was the underperformer in the five-year period.

These performance trends coincided with the sukuk issuance in 2016. According to the Dow Jones Sukuk Total Return Index (ex-Reinvestment), all 19 sukuk added into the index with a tenor of at least five years, six have maturities of 10 years or longer.  In addition, 11 out of 19 are ‘BBB’-rated sukuk, while six have a rating of ‘A’ and only two have a rating of ‘AAA’.

Exhibit 1: Total Return Performance of the Dow Jones Sukuk Maturities-Based Subindices

Exhibit 2: Total Return Performance of the Dow Jones Sukuk Ratings-Based Subindices

Low volatility has been one of the most in vogue strategies during the past decade, with market participants still cognizant of the drawdowns that occurred during the financial crisis.  At S&P DJI, two of the most common strategies are applied to the S&P 500^® universe to capture the low volatility anomaly—which is the observation that over the long term, less-volatile stocks have outperformed more-volatile stocks on a risk-adjusted basis.  Both the S&P 500 Low Volatility Index and the S&P 500 Minimum Volatility Index have historically taken advantage of this anomaly, but the portfolio construction approaches for these indices are quite different.  Exhibit 1 gives an overview of the methodology differences:

The S&P 500 Low Volatility Index employs a rankings-based approach, where stocks in the S&P 500 are sorted by the past one-year volatility of returns, and the 100 stocks with the lowest volatility are selected for index inclusion.  The index does not consider other constraints in portfolio construction (e.g., sector concentration or turnover) and instead simply selects the least volatile stocks.  The S&P 500 Minimum Volatility Index employs what could be considered a more sophisticated approach, using an optimizer and risk model to gain exposure to the price volatility factor, while also controlling for things such as unintended exposure to other factors, active sector weights versus the benchmark, and rebalance turnover.

A simple way to see that the two methodologies can lead to meaningfully different portfolios is to look at the constituent overlap, or how many stocks are constituents of both indices.  At year-end 2016, the S&P 500 Minimum Volatility Index had 96 constituents; just 44 of those were also constituents of the S&P 500 Low Volatility Index—less than a 50% overlap.  The differences in portfolio composition lead to deviations in sector composition, return attribution, and factor exposures, all of which are discussed in our recently released paper, Inside Low Volatility Indices.

Why worry?  New highs for the U.S. stock market indices will keep coming, right?  Just in case, this might be a good time to examine asset classes that are not correlated to the equity market or the “uncorrelated”.

Corporate bonds of the issuers in the S&P 500 are tracked in the S&P 500 Bond Index.  As a group they have seen a negative correlation to the equities market.  Heavily composed of investment grade bonds the index has recorded a positive return of 0.65% year-to-date and a weighted average yield of 3.3%

Investment grade municipal bonds also historically have had negative correlations to the equities markets.  The S&P National AMT-Free Municipal Bond Index has recorded a 0.72% total return year-to-date.  These tax-exempt bonds have a weighted average yield of 2.31%.

Senior loans are higher in the capital market structure than unsecured high yield bonds and are also floating rate instruments.  These characteristics help make them less correlated with the equities market as well as the fixed rate bond markets.  The S&P/LSTA U.S. Leverage Loan 100 Index has recorded a positive return of 0.30% year-to-date.  The floating rate senior loans tracked in this index have a weighted average yield to maturity of 4.76%.

High yield or “junk” bonds tend to be more highly correlated to equities due the their position in the capital market structure.  As a result, junk bond and stock prices can at times move in the same direction based on the market’s perception of the companies strength or weakness.  With a weighted average yield of 5.85% the S&P U.S. High Yield Corporate Bond Index the index is up 1.57% compared to the S&P 500 Index which is up 3.66% (total return).

Table 1:  Select asset classes and their correlations to the S&P 500 Index:

If you buy a little extra chocolate this year for your Valentine, your wallet will be as happy as your sweetheart.  The S&P GSCI Cocoa is at its lowest level (closing Feb. 10, 2017) since Nov. 13, 2008.  It is down 31.3% since last year and is the single commodity with the biggest loss in the past 12 months.  

According to the International Cocoa Organization (ICCO), the cocoa prices decline was initiated from market expectations of a production surplus for the ongoing 2016/2017 cocoa season; mainly resulting from the prospects of a strong recovery in West African and Latin American production. Also, light rains mixed with hot weather and mild Harmattan winds in most of Ivory Coast’s main cocoa growing regions may boost next year’s crop according to farmers.

One thing to love about cocoa besides the fact that it is relatively cheap now, is that it is the commodity with the most favorable dollar movement ratio of commodities that lose from a rising dollar.  It has very little sensitivity to a rising dollar, losing on average just 6 basis points for every 1% rise in the dollar, yet it gains nearly 3.5% for every 1% the dollar falls.

The sports apparel and footwear company Under Armour recently experienced a highly publicized loss of stock value, based on a couple of missteps.  The first misstep was falling short of Wall Street’s earning expectations, which caused multiple brokerage firms to downgrade their stock recommendations.  The second was inaccurate forecasting of the company’s revenue; it only rose by 12%, while the management team had been projecting a 22% increase.  The final misstep was the resignation of the company’s CFO.  Though personal reasons were stated for this, the perception of the change and its timing has turned a concerned eye on the management situation.

Though the current news was unsettling for equities, Under Armour’s debt consists of one bond (USD 600 million at 3.25%, issued on June 15, 2016), which is a component of the S&P 500^® Bond Index (0.013%).  Underneath the S&P 500 Bond Index are two subindices, as the debt in the index is divided into investment grade and high yield.  As of Feb. 9, 2017, Under Armour holds a 0.014% weight in the S&P 500 Investment Grade Corporate Bond Index, and the apparel, accessories & luxury goods industry subsector consists of a 0.08% weight.  The bond has been included among other apparel issuers, such as Coach, Ralph Lauren, and VF Corporation.

In response to the most recent events, the Under Armour bond has been downgraded to BB+ and will be moved out of the investment-grade index and into the S&P 500 High Yield Corporate Bond Index at the next month-end rebalancing (February 2017), as per the index rules.  It will leave behind its investment-grade apparel group to join the high-yield apparel issues of Hanesbrands and PVH Corp., which have a weight of 0.59% as of Feb. 9, 2017, but will increase to 0.72% with the inclusion of Under Armour.

For now, this appears to be an isolated event, as the total return of the consumer discretionary sector, of which apparel, accessories & luxury goods is a component, has continued to provide consistent positive returns (see Exhibit 1).