Indexology^® Blog

Maybe you can’t technically get fired after retiring, but running out of income in retirement is a real risk many people fear.  According to TIAA, 49% of Americans say their No. 1 goal for a retirement plan is to provide guaranteed monthly income in retirement, and 68% of Americans would first choose a retirement paycheck that lasts as long as they live when given a choice of income options.  Yet, 70-80% of new entrants to DC plans (defined contribution) default into predominantly mutual fund TDF’s (target date funds,) which have nothing to do with income.

Recently, S&P Dow Jones Indices had the opportunity to discuss the innovative solutions for managing risk of income shortfall in retirement with Marlena Lee, co- head of research at Dimensional Fund Advisors, and Timothy Pitney, managing director of institutional investment and endowment distribution at TIAA.  In the video below, they point out the risks in managing retirement assets focused on income that have been brought to the forefront, especially since the Pension Protection Act of 2006. 

Sales of new and existing single-family homes have fallen since their recent high in November 2017 while pending home sales are flat to down so far this year.  Starts of new single-family homes are volatile but also remain below the peak seen at the end of 2017.  Recent press reports of declining activity in several major markets including Seattle, San Francisco and New York City confirm the statistics.

One factor depressing home sales is rising prices. The S&P CoreLogic Case-Shiller Home Price indices show prices rising at a 6% annual rate over the last year and a half. The pace may be welcome news to selling homeowners, but it is pricing buyers out of the market. Compared to 6% price gains, inflation is about 2% and wage gains are approaching 3%, squeezing some potential buyers out of the market. Mortgage interest rates are also creeping upward, raising monthly mortgage payments.  The recently passed Federal tax law adds further pressure. The cap of the deductibility of property tax could raise the cost home ownership.

The slowdown in housing is not good news for the economy. While residential construction is a small portion of GDP, sales and remodeling of existing homes affect large sections of the economy. Further, signs that future homebuyers are being priced out of the market will dampen consumer sentiment. Traditionally housing and auto sales follow similar patterns; auto sales are down for much of 2018 though they rebounded in September.

A positive note to end with is the first mortgage default data from the S&P/Experian Consumer Credit Default indices – defaults are lower now than before the financial crisis.

The S&P Indices Versus Active (SPIVA) Europe Mid-Year 2018 Scorecard is often cited for its latest headlines surrounding the active vs. passive debate. But beyond the SPIVA headlines, there is an extensive offering of insightful data that has been carefully measured and presented to help readers dig deeper.

Let’s look at just one example from the latest SPIVA Europe Scorecard and discuss the treasure trove of information that can be gleaned from the report.

Headline: 59% of active pan-European equity funds (euro-denominated) failed to beat the S&P Europe 350 from June 2017 to June 2018.

1. Appreciating the Longer-Term Trends

First, how does this headline figure compare to its track record over longer time periods and to other fund categories?

The proportion of funds in the category failing to beat the same benchmark rose to 87% over the 10-year period. While these figures may appear high, European active funds investing in U.S., global, or emerging market equities appeared to do markedly worse.

2. Assessing Fund Category Performance

Contrary to what the headline may suggest, active funds investing in pan-European equities collectively outperformed the S&P Europe 350 over the one-year period. The average asset-weighted return for the active fund category was 4.02% from June 2017 to June 2018 (equal-weighted return was 3.75%). In comparison, the S&P Europe 350 one-year return was 3.46%.

Asset-weighted returns may be considered a better indicator of fund category performance compared to equal-weighted returns, since they reflect the returns of the total money invested in that particular category with more accuracy. When asset-weighted returns are higher than equal-weighted return calculations, then we know larger funds typically did better.

See how the returns compared to other fund categories in the one-year period and over longer time periods in Exhibit 2.

3. Investigating the Distribution of Fund Returns

We already know there must be a skew in the returns across the funds in this category, since the average fund return beat the benchmark while the majority did not. Put another way, the mean was higher than the median return. The quartile breakpoint report (Report 5 in the SPIVA Europe Mid-Year 2018 Scorecard) takes this analysis one step further by giving the performance of the actual fund, which sits at the 25^th, 50^th, and 75^th percentile by rank.

For our headline category, the third quartile fund had a performance of 0.47% in the year; nearly 3% lower than the benchmark. The first quartile fund had a performance of 5.6% in the year; just over 2% better than the benchmark. This imbalance suggests that relatively few funds may have done particularly well.

4. Analyzing the Survivorship Rates

How does the survivorship rate compare to other fund categories and, more importantly, how consistent is it through time?

The survivorship report in the SPIVA Europe Scorecard tells us there were 1,101 funds used to calculate this headline figure. These funds represent the opportunity set available at the beginning of the period in this category. If we were to calculate the figures using only surviving fund data then any conclusions could be biased by excluding funds that would have liquidated or merged due to poor performance.

Since the headline figure counts the funds that survived and beat the benchmark index, it is also useful to see the survivorship rate in isolation. In this case, 96% of the 1,101 funds survived the one-year period of analysis. Over the 10-year period, the survivorship rate drops to just 45%. As can be seen in Exhibit 3, this is widely typical across all fund categories.

To take a look at more headlines and all of the related reports that help our readers see the full picture, please see the latest SPIVA Europe Mid-Year 2018 Scorecard.

Making a suitable investment decision among multiple options has always been a dilemma. Market-linked investment options have generally resulted in apprehensive views from conservative investors who sense that equity markets bear heavy risks. Retail investors who lack an understanding of the markets are at risk, as bull runs tend to promote participation. Index-based investing can offer exposure to the markets with diversification, low cost, and transparency.

An index is designed to represent a market, sector, strategy, or theme. Investment strategies that replicate the index seek to align their performance to that index’s returns. For example, if an investment strategy were based on the S&P BSE SENSEX, its one-year annualized returns would be approximately 13% as of Sept. 24, 2018.

In the ongoing active versus passive debate, one could argue that active strategies outperform market beta. Could that be true? Yes, provided that a financial market expert makes all the right calls, coupled with the perfect timing. Is it possible for all investors to be such experts and to be vigilant of market movements in order to get the timing right? What about investable funds that are available for professionals who are not financial experts? There are doctors, engineers, architects, and businesspeople in diverse fields who all need viable investment avenues and are constantly researching investment options or reaching out to investment advisors.

Index-based investing can be a good solution to foray into market-linked returns. An index can provide a diverse basket of securities to manage concentration risk. A diversified market index like the S&P BSE SENSEX or S&P BSE 100 can offer exposure across sectors. Access to index information is also not an issue, as index changes are tracked on a day-to-day basis via multiple channels; index movements are displayed on stock exchange websites, past index trends are available on index provider websites, and there are other sources that provide continuous information on market movements. Index-based products have a lower expense ratio than active investing and are therefore a low-cost option. Indices are designed, calculated, and maintained by a neutral index provider, which ensures transparency, standardization, and a lack of bias in the strategy. Furthermore, there are many options for market segments via indices like the S&P BSE SENSEX 50, S&P BSE 100, S&P BSE 150 MidCap Index, S&P BSE 250 SmallCap Index; sector-based strategies via indices such as the S&P BSE Energy, S&P BSE Finance; and thematic strategies via indices like the S&P BSE India Infrastructure Index, S&P BSE Bharat 22 Index, S&P BSE Low Volatility Index, S&P BSE Quality Index, etc.

Last week, the SPIVA Latin America Mid-Year 2018 Scorecard was released. The scorecard tracks the performance of active mutual funds in Brazil, Chile, and Mexico through the end of June 2018. Exhibit 1 shows how managers fared against their respective category benchmarks for one-, three-, and five-year lookback periods.

In the short- and long-term periods, most managers were unsuccessful in outperforming their benchmarks. The lone exception was observed in the Brazil Large-Cap category, where a slight majority outperformed over the one-year time horizon. However, longer measurement periods showed similar results to the other categories, with over 87% of managers underperforming over the five-year period.

Exhibit 2 shows the five-year average annualized fund returns on an asset-weighted and equal-weighted basis within each category. Comparing the two return types can give insight into how managers of different sizes (in terms of assets under management) performed.

For all Brazil categories and Mexico, asset-weighted returns were higher than equal-weighted returns; these results suggest larger managers likely performed better than smaller managers. Chile Equity was the sole category in which the equal-weighted return was higher than the asset-weighted return, meaning smaller managers likely did better than larger managers. Fund category returns calculated either way underperformed their respective benchmarks for all categories besides Brazil Large-Cap. For this category, the asset-weighted return was 9.1% annualized, outperforming the benchmark by 0.9%.

Experience the active vs. passive debate on a global scale on Indexology^®.