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Inside the S&P 500: Dividends Reinvested

SEC Takes a Troubling Step Back from Transparency

Inside the S&P 500: What Made it Rise... or Fall?

Index Rehab: Is Backwardation Back In-Style?

Sell in May and go away. You’re sure?

Inside the S&P 500: Dividends Reinvested

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David Blitzer

Managing Director and Chairman of the Index Committee

S&P Dow Jones Indices

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Slightly more than 400 of the 500 companies included in the S&P 500 pay dividends.  At the current rate, these dividends will be a bit over 2% of the value of the index.  In a strong market like the one enjoyed in the last 12 months when the index price rose over 20%, an extra 2% may not seem like a lot.  In a declining market where every little bit counts, the 2% is very welcome.  However, the impact can be a lot more than just two percent over time.

S&P Dow Jones Indices calculates a total return index for the S&P 500 that includes the impact of investing dividends back into the index itself.   In the calculation, dividends are invested in the entire index, not just in the stock that paid the dividend.  The invested dividends then grow (or fall) as the overall index grows (or falls), rather than tracking the stocks that paid the dividends. This index-wide reinvestment approach is typical in most indices.

The cumulative impact over time can be substantial: the chart shows the S&P 500 price index in red and the S&P 500 total return index in blue. The two data series are calculated to start in January 1988 at the same level.   One thousand dollars invested in the S&P 500 at the end of January, 1988 would have been worth $5557 at the end of July, 2013. However, if the dividends were reinvested in the index, the investment would be worth $10,635 by the end of July.  Reinvesting the dividends roughly doubled the value of the investment.  Looking at the same time period, the annual return earned by the total return index was 9.71% and by the price index was 6.96%, a spread of 2.75%.

500TR

The posts on this blog are opinions, not advice. Please read our Disclaimers.

SEC Takes a Troubling Step Back from Transparency

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Alex Matturri

Chief Executive Officer

S&P Dow Jones Indices

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The Securities and Exchange Commission recently issued exemptive orders to three new exchange-traded funds – essentially granting approval to allow these funds to proceed to market – that dramatically liberalize the operations of “self-indexers”. Such firms not only manage the ETF, they (or an affiliated entity) also maintain the index on which that product is based. As recent headlines have all too clearly demonstrated, serious and costly conflicts of interest arise when proper separation is not maintained between index and product management.

Historically, the SEC required that affiliated index methodologies be made public, that third parties be responsible for calculation of the index and that formal firewalls be in place to protect against information leakage between index maintenance and portfolio management. In these new orders, however, the SEC effectively argues that access to daily ETF holdings are all investors need to be assuaged of concerns regarding potential conflicts. Yet, mere awareness of holdings provides no insight into how or why those holdings were selected or otherwise came to be portfolio components.

The extensive manipulation of LIBOR was facilitated by the lack of controls surrounding benchmark maintenance and product issuance. In response to the scandal, a whole host of regulatory authorities – the International Organization of Securities Commissions (IOSCO), the European Securities Market Authority (ESMA), the European Commission, and others – have sought to dramatically increase the controls and transparency surrounding benchmark maintenance. Why, then, has the SEC moved in the opposite direction? Why do these new orders seemingly run counter to the very notion of transparency, one of the central tenets behind the tremendous acceptance of passive, index-based investing?

The Index Industry Association (IIA), of which S&P Dow Jones Indices is a founding member, recently published a set of standards that define best practices for index providers. These practices are designed to ensure the highest levels of quality and integrity and cover areas such as index governance, the quality and transparency of index methodologies, data collection, and index calculation and validation. It is these very types of protections that regulatory bodies should embrace, rather than adopting practices that threaten the very philosophies that made indexing as reliable and popular as it is today.

The posts on this blog are opinions, not advice. Please read our Disclaimers.

Inside the S&P 500: What Made it Rise... or Fall?

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David Blitzer

Managing Director and Chairman of the Index Committee

S&P Dow Jones Indices

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The first question asked as the market closes is why did it go up? Or, if the results were less appealing, why did it fall?  Either way the usual answer of more buyers than sellers is no answer at all.  The real question is what sectors pushed the market higher or which stocks sent it down.  A little arithmetic with the S&P 500 can go a long way to understanding what is behind a market movement.

Let’s look at July 2013 as an example when the S&P 500 gained 4.95% from June 30th to July 31st before adjusting for dividends.  The contribution of a sector or stock to the overall performance of the index is the weight of the sector or stock at the beginning of the month multiplied by the percentage price increase of that sector or stock.  The table shows the calculations for July:

Index/Sector Performance Share (6-30-13) Contribution
S&P 500 4.95% 100.0% 4.95%
 Utilities 4.2% 3.3% 0.14
 Telecommunication Services -0.7% 2.8% -0.02
 Information Technology 4.1% 17.8% 0.73
 Financials 5.3% 16.7% 0.88
 Health Care 7.1% 12.7% 0.90
 Consumer Staples 3.9% 10.5% 0.41
 Consumer Discretionary 5.1% 12.2% 0.63
 Industrials 5.6% 10.2% 0.57
 Materials 5.5% 3.3% 0.18
 Energy 5.0% 10.5% 0.53

The contribution of a sector depends on both the weight or share and on its performance. Health care was the biggest contributor providing 0.90 percentage points of the 4.95 points the index gained. Financials, which is a larger share of the index (16.7% vs. 12.7% for health care) contributed less to the total performance because it lagged health care’s results.  Fortunately for investors, telecommunication services has a low weight since it was the one sector that slipped on the month.  Since the sector weights in the index are reasonably close to the sector weights for the overall market, looking at the weights can also give some hints to how the market might react.  Materials are 3.3% of the index and gold is in the materials sector — gold’s dramatic rise and fall in recent years was not a major factor in the overall stock market,

One can do the same analysis on a stock by stock basis.  Rather than list all 500 stocks, we can look at just the best and worst, measuring the impact in index points instead of pecentage points of price change. The biggest contributor in July was also one of the biggest stocks, Apple, which saw its stock rise 59 points to 452.5 and added 6.2 index points of the total 72.5 index point gain the S&P 500 index enjoyed. At the other end of the list was Microsoft, which lost 2.8 points to close at 31.83 and subtracted 2.4 index points from the S&P 500.  These are two of the larger stocks in the index, so it shouldn’t be a surprise that they were at the extremes of adding, or removing performance from the overall index.

The same analysis can be done with any division of the S&P 500, or any other index providing one can calculate both weights and performance. Is it more buyers than sellers? No, it’s what they’re buying or selling and how big the things being bought and sold are when compared to the index or the market.

The posts on this blog are opinions, not advice. Please read our Disclaimers.

Index Rehab: Is Backwardation Back In-Style?

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Jodie Gunzberg

Managing Director, Head of U.S. Equities

S&P Dow Jones Indices

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My colleague, David Blitzer, is discussing index construction in his blog series “Inside the S&P 500”, and so far has reviewed selecting stocks and the float adjustment. While the index construction principles of transparency, liquidity, and systematic rules-based methodologies are widely similar between equities, commodities and other asset classes, there are details that distinguish the asset classes. For example, market capitalization and style like growth or value may be associated with equities while credit quality and duration may be linked with bonds. The main features of commodity indices are weightings, rolls, and regions.

Since 2007, there have been a number of new commodity indices created to modify the first-generation flagships, the S&P GSCI and DJ-UBS, intended to improve the returns and reduce risk. However, as my colleague, Craig Lazzara, points out, newer developments to flagship indices don’t necessarily create smart beta so he prefers the term “alternative beta, because calling it smart beta implies the beta you get from the S&P 500 (or flagship) is dumb”.

He couldn’t have stated that concept any better for commodities. The S&P GSCI and DJ-UBS have been criticized for their basic strategy of holding the most liquid front-month contracts that lose from negative roll yield when exiting the expiring contract and entering the new contract every month when the later-dated contract is more expensive, or in contango. The blame comes from investors who were allocating to commodities in the time period between 2005 and 2011 when contango was the prevailing condition in 93% of months. For them, alternative beta that modified rolls or weights may have seemed to be the smarter solution since backwardation was a thing of the past. However, today that wisdom may not hold true because while the persistence of backwardation hasn’t been seen since prior to 2005, backwardation (as measured by the difference between the excess return and price return versions of the  S&P GSCI), appeared in 5 months in 2012 an has now continued this year since May.

There is a noticeable shift of world growth that may be causing backwardation to reappear. A number of characteristics of world growth driven by expansion of demand are becoming more widespread by the move from world growth driven by expansion of supply.  These factors are getting stronger since last year and they may drive the frequency and magnitude of cycles higher that may increase the incidence of switching between contango and backwardation.

New World

Also from this shift, the inventories are lower so commodities have been more sensitive to supply shocks than they have been in the past as evidenced by the moves in gold, livestock, and energy. Given that price shocks are differentiating factors between commodities, for example, a drought may affect corn but not gold or a pipeline burst may drive oil but not sugar, there should be more focus on fundamentals.  This is important since diversification may start to overcome the risk-on/risk off environment as discussed in a paper by Hilary Till, EDHEC-Risk Institute. (she will also discuss this in her keynote at our upcoming commodity seminar)

Price Sensitivity

In the possible divergence of individual commodity performance, one component to watch is petroleum since the oil term structures are sensitive from the challenging storage situations. The global impact of the U.S. shale energy boom may be a significant force in shaping the return opportunities ahead just as the increased pipeline capacity has been supporting the S&P GSCI Crude Oil (WTI) and S&P GSCI Unleaded Gasoline.  The environment may have a large positive index impact from backwardation, particularly in the S&P GSCI with its relatively heavy energy weight. If this is the case, the index rehab that intended to upgrade the basics may have gone out of style – at least for now.

 

 

The posts on this blog are opinions, not advice. Please read our Disclaimers.

Sell in May and go away. You’re sure?

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Jamie Farmer

Chief Commercial Officer

S&P Dow Jones Indices

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We’re all familiar with that old adage.  The theory says that trading slows during the summer months, markets can be a bit more turbulent and you’re better off closing out your positions, getting to the beach and enjoying your Pimm’s Cup in relative peace.

But as my colleague Craig Lazzara pointed in his recent post, investors that bailed out this May would’ve missed a decent July.  Further, we know that the adage isn’t an absolute.  Historically, it may be true that the 6 months from May to October underperform those from November to April, but that doesn’t mean there is no absolute performance to be gleaned.  Our cousin colleague Sam Stovall, chief equity strategist at S&P Capital IQ, says when stocks start the year off strongly there are often gains to be had during summer vacation (from his report “Sell in May and go…where?”, April 22, 2103).  And this year clearly did have a strong start, with the DJIA up 19.95% YTD through July.

So, how has this period performed in recent decades?  To compare this year to years past, we looked at the average price return of the Dow Jones Industrial Average from May to July.  This year’s performance of 4.45% compares very favorably to the average of .85% from 1950 to 2013 and is the best May to July period since 2003 when the DJIA was up 8.89%.  Over those 64 years, the split of positive vs. negative periods is exactly 50/50 – positive periods average a 5.98% gain and the negative average a 4.28% loss.

As always, investors are best served by not accepting the conventional wisdom at face value.

The posts on this blog are opinions, not advice. Please read our Disclaimers.