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Australian Corporate Bonds Outperformed the Market

Inside the S&P 500: Multiple Share Classes and Voting

The Next Big Futures Market May Be OUT OF THIS WORLD or in CHINA

Wall Street’s Version Of Black Friday

Bond Funds Unbound

Australian Corporate Bonds Outperformed the Market

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Michele Leung

Director, Fixed Income Indices

S&P Dow Jones Indices

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Tracked by the S&P/ASX Corporate Bond Index, the size of the Australian dollar denominated corporate bond market currently stands at 57 billion, which is one-tenth of the broader benchmark, the S&P/ASX Australian Fixed Interest Index. While the corporate sector is relatively small in Australian bond market, the size actually grew more than 80% since the index incepted in 2005.

In fact, if we trace back to the history, the corporate bond market has undergone a vast development. Since the early 80s, there was a transition from predominantly publicly owned issuers to private issuers. Driven by the deregulation of the financial system and removal of capital control, a solid growth in corporate bond market, particularly bank bond issuance, was observed.

Although some corporate issuers are attracted to the offshore market, as to minimize and diversify their funding cost and also to match their foreign currency revenue streams, it is also witnessed there is a strong investor demand in the corporate bonds denominated in Australian dollar.

Benefited from the continuous hunt for yield, the S&P/ASX Corporate Bond Index delivered a robust total return of 3.95% year-to-date (YTD), as of December 5, 2013. The corporate bonds outperformed the market, compared with the 0.09% YTD gain of S&P/ASX Government Bond Index. The yield to maturity grinded 20bps tighter to 4.31%, it is appealing in this low rate environment and considered the minimum credit rating for index inclusion is BBB-/Baa3/BBB-.

The investor appetite for the risk-adjusted return is also reflected in the tightening spread to the Australian government bonds. As shown in Exhibit 1, the spread has already contracted from 1.37 a year ago to currently 0.65 level, which is also the tightest level that spread reached in 2006. It means the investors are now accepting a lower relative yield to own the risker asset.

Perhaps it seems to hint that investors are now ready for the further expansion in corporate bond market…

Current Spread of S&P/ASX Australian Government Bond Index

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

Inside the S&P 500: Multiple Share Classes and Voting

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David Blitzer

Managing Director and Chairman of the Index Committee

S&P Dow Jones Indices

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Google’s expected stock split has focused attention the treatment of multiple share classes in the S&P 500 and other indices. Most US companies, but not all, have only one class of common stock and each share is entitled to one vote.   In some companies with multiple share classes, one class is publicly traded and the other classes are closely held and couldn’t be included in an index. However, there are other companies with multiple classes where more than one class is listed and traded.  Berkshire Hathaway is one of the better known cases; the class A shares traded recently (December 6th 2013) at about $174,320.00 per share while the class B shares were trading at about $116 per share the same day. The A shares carry one vote, the B shares one-ten-thousandth of a vote; the price ratio is 1500 times.

In the S&P 500 each company is represented by only one share class. Some other indices include multiple share classes of the same company meaning that an investor’s economic exposure to the company can be larger than it appears.  Multiple share classes are often used to permit the founders or the insiders to retain voting control while owning less than 50% of the outstanding stock. In other cases, the lower price class also makes the stock more readily available to investors. Typically one class of a multiple share class name is more liquid than the others and represents a substantial majority of the trading. With Berkshire Hathaway it should be no surprise that most of the trading is in the B class and that the S&P 500 includes the B class. However, Berkshire’s A class represent slightly more than half the value of the company.  So that the S&P 500 reflects the total float adjusted market value of the entire company, the share count of the B class is adjusted to reflect the combined float of both share classes.  This gives a proper picture of the company’s value while maintaining the liquidity of the index.

There is no adjustment for differing voting rights among multiple share classes of a single company.  Such an adjustment is often not even feasible because one class of stock has no voting rights at all or the ratio of the prices of the two classes differs from the ratio of the votes.  In some cases the price differential maybe quite small.  Comcast CMCSA, with one vote, recently traded at about $49.24 while CMCSK with zero votes was $47.61. (Prices on December 6th 2013).  The extent to which a group of investors could use their votes to force a change in a company’s management or strategy depends on more than just the number of votes per share.  In many companies with a single share class and one vote per share, the management may own more than 50% and be seen as insulated from independent shareholder pressure.  In other cases, where there are multiple classes and one class is “super voting” the company may still prove vulnerable to a take-over.  One example is Dow Jones, acquired by News Corporation a few years ago.

Challenges for index maintenance include choosing the more liquid share and how to handle any shift from one class to another.  Usually the class with the larger number of shares in the public float and with the lower price, if there is a substantial spread, will be more liquid. As mentioned, the choice was easy with Berkshire Hathaway. (Berkshire did not join the S&P 500 until the float in the class B was large enough; adding the class A to the index would have presented problems for indexers.) In some cases, classes have been switched. One example is Comcast where an acquisition for stock resulted in a large increase in CMCSA and it replaced CMCSK in the S&P 500.

Google currently has two classes of stock; class A is in the S&P 500 and carries one vote while class B has ten votes and is closely held.  Google is expected to split both classes by distributing shares in a new class C which will have zero votes per share.  Because each A share and each B share will receive one C share in the split, the new class will be the largest when the split occurs.  Moreover, Google expects any future share issuance for employee compensation, acquisitions or other reasons will be class C shares; the Cs will always be the largest class.  The question for the S&P 500 Index Committee is which class will be in the S&P 500 over the long term and, if need be, how to manage the switch from class A to class C.  These issues are under review, stay tuned for an announcement.

Other posts on Inside the S&P 500  on dividends, on float adjustment and on selecting stocks

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

The Next Big Futures Market May Be OUT OF THIS WORLD or in CHINA

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Jodie Gunzberg

Managing Director, Head of U.S. Equities

S&P Dow Jones Indices

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In my post about globalizing futures, technology and logistics were highlighted as key factors to expand local commodities into a global commodities.  What I failed to mention is that these same keys may unlock potential futures markets growth beyond Earth.  That may seem extraordinary but the potential is real since according to this article on NPR, NASA is planning to grow cress, turnips and basil on the moon.  While it is interesting to think about the spread opportunities that may exist one day between global and extraterrestrial contracts, it may just be that out of this world contracts are so fabulous that they command a fixed premium.

Back to Earth now… The more realistic next big futures market may be in China. I am visiting Shenzhen this week for the 9th Annual China Derivatives Forum, where thousands have gathered to discuss openness, innovation and cooperation in the Chinese derivatives markets.  Many lessons can be learned from the US and Europe, where derivatives markets are more developed, which may help in China’s quest to develop commodity futures.

During my visit, I met with several journalists looking to highlight the importance of China in the commodities markets going forward.  Below is a summary of the most frequented questions:

Q1: How important is the development of China’s futures markets?  The development of China’s futures markets can be highly important for the continued growth of both local and global markets. With growing futures markets, there is greater incentive to produce and store since insurance against price fluctuations is available. This may consequently reduce the volatility of prices for the inputs to goods and help consumers with price certainty. However, there is greater risk-bearing for producers, so to the extent that China is a major consumer and that consumers have choices unavailable to producers, the futures markets may play a lesser role.

Q2: What needs to occur to facilitate the growth of the Chinese futures markets and to get them represented in the major indices? Greater openness, collaboration and continued innovation may be catalysts to help China’s market grow.  Futures contracts that reflect the underlying local physical markets are important to attract commercial hedgers who are in need of protection against price moves. Once there is sufficient liquidity in these contracts, independent indices can be developed only if price data is available for use in the calculation of the index levels.

Q3: For Chinese investors, how do you think they should invest in global commodity indices? Hopefully Chinese investors can enjoy the same benefits as other investors around the world, which have historically been diversification, inflation protection and the potential for equity-like risk and return.  Diversification is now more prevalent since the high inventories have fallen and commodity prices have become more sensitive to supply shocks, which have reduced correlations of individual commodities to each other and commodities to other asset classes to pre-crisis levels,

Q4: What role does China play in the global commodity market, both as a driver and as a trading platform? China is a major consumer of commodities so the demand growth is a key factor in the price formation of commodities globally. As a trading platform, China is developing quickly though their exchanges but products are still in their infancy stage of development.  This may be good news since already there have been about 10 new contracts to market in the past year including some major launches on iron ore, lumber, and crude oil. For areas where there are no great developed futures market like iron ore and lumber, there is an exciting opportunity for diversification.  For commodities that already have developed markets then the question becomes about the similarities and differences between the contracts.  Maybe the popular Brent-WTI spread will get another leg if the Chinese oil contract creates more opportunity.

Q5: How does the impact of demand growth differ between China and India? The demand growth of any consuming country has an impact on commodities.  While much attention surrounds gold demand in India, I think what is really important is the demand growth of oil from India. India is one of the top 10 oil consuming countries in the world and it has the highest projected demand growth rate.  In 2013 demand growth was 46 kb/d or 1.4% and in 2014, the projected rate is demand growth of 3.1% or the equivalent of 104 kb/d added to consumption (according to the Oil Market Report by the IEA).

Q6: What will drive commodities in 2014? The major factors set to influence commodities next year are the quantitative easing, Chinese demand growth and geopolitical tensions. While the Eurozone debt is still on the horizon, the concern seems to have subsided compared with the sentiment a year ago.

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

Wall Street’s Version Of Black Friday

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Kevin Horan

Director, Fixed Income Indices

S&P Dow Jones Indices

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It’s widely known that Black Friday, the Friday after Thanksgiving, is the traditional kickoff for the Christmas shopping season. Much like retail shoppers, Wall Street is experiencing a similar event though it does not come with such a defined time period. Early indications of companies attempting to time corporate issuances came in September of this year when Verizon Communication Inc. issued $49 billion corporate bonds just prior to the Sept. 18 FOMC rate decision.  These bonds were very well received by the investor community and, for the bonds that met qualification rules, were eventually added to the S&P U.S. Issued Corporate Bond Index.

It was reported in the press that Verizon executives wanted to sell as many bonds as possible the first time around. By wrapping up the financing early, Verizon essentially eliminated the threat of rising interest rates. The S&P/BGCantor Current 10-Year U.S. Treasury Index’s yield-to-worst had risen 19 basis points from the beginning of the month leading into the September Verizon deal, as market participants worried about the effects of Fed tapering. After the announcement and reassurance of continued stimulus, the index’s yield-to-worst advanced lower, eventually reaching a low of 2.50% on Oct. 23. Since then, yields have started trending back up and discussions have been renewed surrounding the timing of any action in regard to the Fed’s tapering of its stimulus purchases.

As a result of these trends, corporate issuers are once again looking to time their issuance before any significant rate action occurs. The next FOMC meeting is scheduled for Dec. 17-18, and already we’ve seen issuers such as Microsoft Corp. ($3.25 billion) and Johnson & Johnson ($3.5 billion) come to market with issues spanning maturities from three years to 30 years out. The majority of issuance for these two deals meets the S&P U.S. Issued Corporate Bond Index qualification rules except for the $800 million Johnson & Johnson floating rate notes due 11/28/2016, which, as stated in the index methodology, are excluded for not being fixed rate. The demand for yield is strong and the recent increase in rates has whet the appetite of investors while still remaining attractive to corporate CFO’s. We could see further corporate issuance this year as firms attempt to secure financing before any possible increase in rates may occur.

S&P/BGCantor Current 10 Year U.S. Treasury Bond Index

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

Bond Funds Unbound

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Craig Lazzara

Managing Director and Global Head of Index Investment Strategy

S&P Dow Jones Indices

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Yesterday’s Wall Street Journal offered a profile of fixed income investors who aim to “break [the] chains” by which they are supposedly confined by index benchmarks.

As the bond market falters, investors are seeking shelter in funds that aren’t tied to indexes.  These bonds funds are known as “unconstrained,” “go-anywhere,” “absolute return” or “flexible” funds, and they are gaining in popularity on both sides of the Atlantic…

This echoes a theme we also hear in the equity markets — that managers need to be “more aggressive” (typically by holding fewer stocks) in order to improve their performance.

Improving performance is not quite as easy as the article implies.  Moreover, investors, both institutional and individual, compare managers to indices for a very good reason.  The reason is that absent some objective standard, the fund owner has no way to judge whether the asset manager’s performance was good, bad, or indifferent.  Admittedly, “some objective standard” covers a lot of ground — not losing money in a quarter, or earning at least 10% a year, are both objective standards.  But indices are uniquely well-suited to be the standard by which asset owners evaluate asset managers.

Most broad market indices — whether they measure equities or bonds — are capitalization-weighted.  Such an index will accurately reflect changes in the total market value of the asset class in question.   One of the most important characteristics of any asset class is that there is no net supply of alpha.  In other words, one manager can be above average only if another manager is below average.  The aggregate amount by which the above-average managers outperform the asset class must equal the aggregate amount by which the below-average managers underperform.

By comparing manager performance to that of a well-diversified, cap-weighted index, an asset owner realizes two benefits:

  • He assures himself that his bogey is reasonable in view of the opportunity set available to his managers.  In 2011, with the S&P 500 up 2%, it would have been foolish to expect a U.S. equity manager to meet an absolute 10% bogey.  This year, with the 500 up 29% through November 30, it would be equally foolish to be satisfied with 10%.
  • Since there is no net supply of alpha, roughly half of all managers will outperform their asset class and roughly half will underperform.  As a convenient shorthand, a manager who beats a well-diversified cap-weighted index is likely to be an above-average manager.

There are as many putative paths to outperformance as there are active managers (or active managers’ marketing departments, which is more or less the same thing).  None of them will be impeded by asset owners’ use of well-chosen indices to evaluate manager performance.

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