Indexology^® Blog

Here are six notable developments in the U.S. financial markets in September 2017.

1. Smaller caps outperformed large caps.
2. Value outperformed growth.
3. Energy was the top-performing sector, and the utilities sector was the worst-performer.
4. Developed markets posted gains, while emerging markets lost steam.
5. Commodity indices rebounded, driven by recent strength in energy.
6. U.S. 10-year and 30-year Treasury yields rose.

What do these events have in common?

They are all reversals from the January-August 2017 period, where large caps outperformed smaller caps, growth outperformed value, and energy lagged due to weakness in oil compared to the utilities sector, which was the second top performer in August.  Meanwhile, emerging markets outperformed developed ex-U.S. markets, while Treasury yields fell.

What was different about September 2017?

The bull market in equities deepened through the cap spectrum.  While smaller caps, value, and energy still lag on a YTD basis, the S&P SmallCap 600^® was up 8% in September 2017 compared to the S&P 500^®’s 2% gain.  Similarly, the S&P 500 Value gained 3% compared to the S&P 500 Growth’s 1% gain.  Energy made a turnaround as the top-performing sector in September, thanks to the rebound in oil prices, which also drove the gains in the S&P GSCI.  Meanwhile, utilities performed poorly in September, declining 3%, a reversal from the prior month, indicating market participants’ return to a risk-on appetite.  Emerging markets also stumbled, with the S&P Emerging BMI down 1%.

Is the “Trump” trade making a comeback?

Flash back to November 2016, when the U.S. equity markets and small caps in particular rallied post the U.S. Presidential election, with the S&P SmallCap 600 up 13% that month, while emerging markets declined.  Treasury yields rose, while energy posted gains and the utilities sector was the worst performer.  The S&P 500 Value gained 6%, outperforming the S&P 500 Growth’s 1% gain.

November 2016’s market performance sounds eerily familiar to that of September 2017.  We would argue that these themes are not six independent things—they are six different manifestations of one “big thing”.  That “big thing” is the perception that the U.S. economy is strong and poised to continue growing at a rapid clip.  One of the drivers of this perception is the possibility of growth-oriented tax reform, which will aid in boosting companies’ earnings and thereby solidify market fundamentals.

Will the coming months offer a continuation of these trends?  We caution that predicting market outcomes is challenging given the many geo-political uncertainties at stake.  Time will tell.

The active versus passive debate has been a continuous subject of discussion in the evolving asset management industry.  S&P Dow Jones Indices launched the first SPIVA India scorecard in 2013 to provide a barometer on this subject. The Indian market has witnessed significant growth (albeit from a small base) in passive investment products that offer lower cost and more transparent access to targeted segments of the market compared with the actively managed products.  Passive investment products have been evolving, and there have been an increasing number of products that implement various investment strategies that were once considered exclusive tools used mostly by active fund managers.

Exhibit 1 reviews the percentage of funds that underperformed their respective benchmarks in each category for the five-year rolling period between December 2013 and June 2017.  The majority of Indian Equity Large-Cap, Indian Government Bond, and Indian Composite Bond funds underperformed their respective benchmarks for most of the period.  Indian ELSS funds had the highest percentage of actively managed funds leading the benchmark over the period.

Exhibit 1: Percentage of Active Funds That Underperformed Their Respective Benchmarks (over a rolling 5-year horizon) 

Source: S&P Dow Jones Indices LLC.  Figures based on Mid-Year and Year-End SPIVA India scorecards since December 2013 to June 2017.  Chart is provided for illustrative purposes.  Past performance is no guarantee of future results.

Indian Equity Large-Cap funds generated relatively slight excess returns over the S&P BSE 100 for the five-year rolling horizon (see Exhibit 2).  Moreover, more than 50% of funds failed to beat their benchmarks.  Both categories of bond funds—Indian Government Bond and Indian Composite Bond—generated negative excess returns for the five-year rolling horizon, with more than 75% underperforming their respective benchmarks as of June 2017.

Among all the fund categories, the Indian ELSS and Indian Equity Mid-/Small-Cap funds offered the most pronounced excess return over their benchmarks, the S&P BSE 200 and S&P BSE MidCap, respectively. On average, Indian ELSS and Indian Equity Mid-/Small-Cap funds offered an annualized excess return of 225 bps and 402 bps, respectively, over the five-year rolling horizon (see Exhibit 2).  After a relook at Exhibit 1, we notice that in the case of the Indian Equity Mid-/Small-Cap category, a fairly large percentage (approximately 40%) of the funds underperformed their benchmark.  Hence, in this category, picking the right active fund becomes critical.

Exhibit 2: Rolling Annualized Excess Returns of Equal-Weighted Funds over Their Respective Benchmarks (over a rolling 5-year horizon) 

Source: S&P Dow Jones Indices LLC.  Figures based on Mid-Year and Year-End SPIVA India scorecards from December 2013 to June 2017.  Chart is provided for illustrative purposes.  Past performance is no guarantee of future results.

The SPIVA Latin America Mid-Year 2017 Scorecard was released this week.  The report covers Brazil, Chile, and Mexico in selected fund categories.  In line with the rest of the world, widespread gains were seen in both fixed income and equity markets in Latin America in the first six months of 2017.

The recent rise in the markets didn’t lead to outperformance by active fund managers against category benchmarks, as the majority of managers underperformed across all categories measured.  The percentage of funds outperformed by benchmarks in each category for the one-, three-, and five-year performance lookback periods are shown in Exhibit 1.

In addition to reporting outperformance, the SPIVA scorecard calculates the average fund returns on an asset-weighted and equal-weighted basis.  Conventional wisdom says that funds with larger asset bases have higher economies of scale and better execution than smaller funds, thereby potential ly delivering higher net returns all else equal.  Therefore, if asset-weighted returns are higher than equal-weighted returns, then larger funds did better than smaller funds.  Using data from Report 3 and Report 4 in the SPIVA scorecard, Exhibit 2 compares asset-weighted and equal-weighted returns over a five-year time horizon.

For six of the seven categories, asset-weighted average returns are higher than equal-weighted average returns—the lone exception being Chile Equity.  The most notable difference in returns is in the Brazil Equity category, with the asset-weighted average return 3.1% higher than the equal-weighted average return.

To see the full SPIVA Latin America Mid-Year 2017 Scorecard, please click here.  To dig deeper into SPIVA in Latin America, please watch our webinar replay.

• The energy fundamentals, helped by Hurricane Harvey, are now in place for solid rebalancing and for potentially continued strong performance.
• Metals have reflected bullish sentiment but have recently been hindered by Chinese growth and credit concerns.
• Agriculture has been well oversupplied on better than expected weather and from improving farming technologies.

In September, three of five sectors were positive and thirteen of twenty four commodities were positive in the S&P GSCI Total Return that had an overall return of 3.3% in the month, 7.2% for the third quarter and -3.8% year-to-date.  Energy was the best performing sector for the month, returning 5.9%, while the precious metals sector lost the most, down 3.0% in September.  Gasoil was the winning single commodity for the month with a gain of 9.3%, and nickel lost 11.3% in the month, making it the most losing single commodity.

During the month, oil entered a bull market since the June 21, 2017 bottom with Brent Crude up 26.1% and (WTI) Crude Oil up 21.5% from better OPEC compliance, hurricane Harvey, and strong demand growth. Brent backwardation is the most since June 2014, and WTI crude oil contango was smallest since Dec 2014, before the storm but refinery disruptions and demand slowdown boosted the contango again to the highest since Jan 2017.

The after-effects of hurricanes generally have an impact on the commodities market. Hurricane Harvey caused gas prices to rise because the infrastructure needed to transport the gas to the refineries in Texas was badly damaged, but the price has come down as refineries come back online.

On the other hand, gasoil has continued to rise from not just the supply disruption, but also from the increased demand of fuel for machinery in construction for the rebuilding in the aftermath of the hurricanes.

Overall, the disruption to the energy supply led energy to have its best month yet in 2017, and again could be a solid foundation for the market to rebalance. On the flip side precious metals lost 3.0% in September, led by gold down 2.8%, posting the worst month (for both precious metals sector and gold single) not just this year but since Nov, 2016.  This is from a rising dollar and expectations of a rate hike.  This split shows the fundamentals are overtaking the aggregate demand in driving commodities today.

For more on quarterly performance, please see this article and this one too.

According to the latest Department of Labor statistics, more than 640,000 employer-sponsored defined contribution (DC) plans are in existence in order to help nearly 90 million participants prepare for retirement.[1] To date, traditional measures of success included factors based on a plan’s inputs, such as participation rates, savings levels, and the relative performance of underlying investment options. Measuring these input-focused metrics may not, however, accurately capture a plan’s potential to provide its participants with retirement income adequacy (a common goal for most participants).  The Defined Contribution Institutional Investment Association (DCIIA) addressed this concern, creating a best practices framework[2] for plans with an objective of retirement income adequacy.  Key takeaways highlighted for plan sponsors include a need for updated plan design, an outcome-based Investment Policy Statement and new benchmarks for plan success.

Plan Design

When it comes to investment menu offerings, less may be more. While plan sponsors should seek to avoid overwhelming participants with too many options, the addition of a stand-alone income focused option may offer participants the ability to target a desired standard of living in retirement while concurrently signaling the need to consider income as a planning goal.  Research has shown that many American workers – even those approaching retirement – lack even a rudimentary retirement plan.  Of those who do have a plan, most plan a mere five years into retirement, rather than a far more likely retirement time horizon, such as 20-30 years.[3]   Now is the time for plan sponsors to evaluate the variety of available options and choose the arrangement that best suits their plan demographics.  Placing such an option alongside a conventional target date series, for example, may not only help participants plan for retirement income but also emphasize the importance of doing so!

Focusing on Outcomes

When evaluating the success of a retirement plan, sponsors should consider output-focused metrics, such as income replacement ratios by employee cohort.  An income replacement goal that takes employee demographics into consideration (such as salary) might be an appropriate metric for plan sponsors to consider.  One of the few studies that discuss replacement and savings rates by income cohort is by Massi De Santis and Marlena Lee[4]; the findings of which can be useful when designing an outcome-focused Investment Policy Statement (IPS).  Taking this step helps lay the foundation for what many plan sponsors are focusing on; the ability to better evaluate the success of an income focused default option and the plan as a whole.

Benchmarking Success

Many tools, such as the S&P Shift to Retirement Income and Decumulation (STRIDE) Index Series, which can serve as a benchmark for income-focused retirement strategies, are available from service providers to assist with this evaluation. It can also be important for sponsors to incorporate additional sources of income tools, such as Defined Benefit and Social Security payment estimates, to provide a more complete picture of participants’ sources of retirement income.

Measuring retirement readiness not only helps gauge the overall effectiveness of a DC plan, but it also helps identify at-risk employee populations that may require further attention to increase the likelihood of adequate retirement savings.  Focusing on income as the outcome is an important first step in helping participants meet their replacement income goals; effective progress means continuing to evaluate new income-focused solutions, improving plan metrics and utilizing relevant benchmarks to measure success.

⁴ Massi De Santis and Marlena Lee, “How Much Should I Save for Retirement”, Dimensional Fund Advisors, June 2013.

The S&P STRIDE INDEX is a product of S&P Dow Jones Indices LLC or its affiliates (“SPDJI”), and has been licensed for use by Dimensional Fund Advisors LP (“Dimensional”). Standard & Poor’s® and S&P® are registered trademarks of Standard & Poor’s Financial Services LLC (“S&P”); Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”); these trademarks have been licensed for use by SPDJI and sublicensed for certain purposes by Dimensional. Dimensional’s Products, as defined by Dimensional from time to time, are not sponsored, endorsed, sold, or promoted by SPDJI, S&P, Dow Jones, or their respective affiliates, and none of such parties make any representation regarding the advisability of investing in such products nor do they have any liability for any errors, omissions, or interruptions of the S&P STRIDE Index. Dimensional Fund Advisors LP receives compensation from S&P Dow Jones Indices in connection with licensing rights to S&P STRIDE Indices.

Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission. Dimensional Fund Advisors and Strakosch Retirement Strategies are unaffiliated entities.

This article is offered only for general informational purposes; it does not constitute investment, tax, or legal advice and should not be relied on as such.

[1] U.S. Department of Labor Employee Benefits Security Administration, “Private Pension Plan Bulletin –

Abstract of Form 5500 Annual Reports,” October 2014.

[2] See DCIIA White Paper: Defined Contribution Plan Success Factors, Framework for Plans with an Objective of Retirement Income Adequacy, May 2015.

[3] Society of Actuaries, “2011 Risks and Process of Retirement Survey Report of Findings,” March 2012.