Investment Themes

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Two Dimensions of Risk

Facebook Selling Into the S&P 500

Eighty-one years later...

The year in balance

The Persistence of Non-Persistence

Two Dimensions of Risk

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Craig Lazzara

Managing Director and Global Head of Index Investment Strategy

S&P Dow Jones Indices

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Investors have long regarded the market’s overall level of volatility as an indication of its riskiness.  The S&P 500 VIX Index, in particular, is often referred to as a “fear gauge” for U.S. equities since it tends to rise when investors are nervous and to fall when the markets are quiescent.

Although S&P 500 VIX has a strong claim to be primus inter pares in the volatility family, the family is large and growing.  Earlier this week we introduced a new volatility and dispersion dashboard designed to help investors analyze trends in VIX and to comment on their implications for market developments.  We were able to observe, e.g., that spot VIX was higher than the January VIX futures — an unusual alignment reflective of the market’s uncertainty about yesterday’s FOMC announcement.

Volatility gives us one way to measure risk, but vol itself is importantly influenced by a simpler but less well-known metric called dispersion.  Think of dispersion as the difference, over a given period of time, between the “best” and the “worst” performers in a market index.  If dispersion is low, the gap between “best” and “worst” shrinks.  When that happens, any strategy that deviates from cap-weighted indexing — from a disciplined factor index to the most aggressive fundamental stock picking — will have less opportunity to add value than it would have had in a period of high dispersion.  And when dispersion is low, other things equal, volatility will also tend to be low.

That’s the situation in which we find ourselves today.  Although VIX has risen in the last month, it’s still well below its typical levels.  Not surprisingly, stock market dispersion is also near its historical lows.  We’d expect that in such a low volatility, low dispersion environment, active alpha will be both scarce and small.

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

Facebook Selling Into the S&P 500

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David Blitzer

Managing Director and Chairman of the Index Committee

S&P Dow Jones Indices

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Facebook (FB), the most-watched candidate for the S&P 500 all year, will join the index tomorrow night, December 20th , after the market closes. Once ETFs, index mutual funds and other index funds complete their buying – probably sometime next week – roughly 12% of FB’s shares will be held by indexers.  As many expected, the stock jumped up on our December 11th announcement that FB would join the index. Moreover, FB outperformed the S&P 500 from December 11th to yesterday (December 18th) by 9.5 percentage points.

Hedge fund and arbitrageurs sometimes trade index additions hoping to profit from the expected stock bounce.  Dating back to the tech boom of the 1990s, when index adds and drops first drew a lot of attention, the company joining the index often sells stock through a secondary offering to take advantage of the demand for shares created by the index addition. FB is following this pattern – it is offering 70 million shares of its class A common stock, about 3% of the current outstanding float. Included in the 70 million are about 41.4 million shares being sold by Mark Zuckerberg, FB’s founder.

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

Eighty-one years later...

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Tim Edwards

Managing Director, Index Investment Strategy

S&P Dow Jones Indices

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Harbouring year-end reviews and final accounts, the last weeks of December are infused with nostalgia. In this seasonal spirit, I’d like to draw your attention to an under-celebrated piece of work, completed in the year that Katharine Hepburn, Cary Grant and Shirley Temple saw their debuts on the silver screen. In 1932, Fred had not yet met Ginger, ground had just been broken on the Golden Gate Bridge, and on New Year’s Eve, a joint meeting of the Econometric Society and the American Statistical Association considered the results of an inquiry that opened the debate between active and passive management.

The question “Can Stock Market Forecasters Forecast?” is a natural one to ask. The economist Alfred Cowles III was probably the first to investigate this question empirically. In July 1927, he began collecting information on the equity investments made by financial institutions of the time as well as on the recommendations made by various “oracles” in contemporary financial media, embarking on a multi-year project to record and evaluate their performance. It was a heroic effort: over 7,500 recommendations and transactions tracked and tabulated, against hundreds of stocks prices and dividends collected by hand over 4 ½ years.

Importantly, Cowles didn’t just measure absolute performance. He also compared the returns to what “the market averages” (in his case, the Dow Jones Industrial Average) would have achieved. Using fairly modern statistical techniques1 combined with meticulously hand-drawn charts, Cowles expertly diagnosed contemporary active management: poor on average; appearing skilful most probably through sheer luck.

Cowles

Source: Cowles ; “Can Stock Market Forecasters Forecast?” ; Econometrica, Volume 1 Issue 3 (1933)

Cowles presented his research on December 31st, rounding off a year in which he also established the Cowles Commission for Research in Economics, subsequently to become a veritable breeding ground for Nobel-prize winning ideas (Robert Shiller’s being the most recently recognised).

And his comparison of stock selection strategies to market averages and random portfolios is thoroughly modern.   With almost identical methods and conclusions2, the progeny of Cowles’ research continue to stimulate debate.

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  1. Cowles’ ideas are considerably ahead of their time. His use of playing cards to simulate random portfolios is a more than a decade prior to Stanislaw Ulam’s & Von Neuman’s celebrated first use of the “Monte Carlo” method at Los Alamos in work relating to the development of the hydrogen bomb.
  2. Today a market-cap weighted benchmark is usually seen as the bogey, but it would be more than 30 years before William F. Sharpe explained why.

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

The year in balance

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David Blitzer

Managing Director and Chairman of the Index Committee

S&P Dow Jones Indices

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The US stock market did very well in 2013, up 25% (before dividends) through December 16th, with better results than the overall economy and most other developed markets.  The one big exception is Japan where the market is up almost 47% in Yen terms, though within a percentage point of the S&P 500 when measured in US dollars.

Looking across the US market, growth and value, and all ten sectors, showed results broadly similar to one-another.  Unlike some past years, no single sector or style accounted for the lion’s share of the gain. 

Sector Rank Price ‘Return
Cons Discretionary 1 36.4%
Health Care 2 34.4%
Industrials 3 32.0%
Financials 4 29.1%
InfoTech 5 21.1%
Consumer Staples 6 20.0%
Energy 7 18.1%
Materials 8 16.8%
Utilities 9 7.1%
Telecomm 10 3.9%

Likewise, growth and value came in very close with growth up 25.9% and value up 24.5%.

Where did the balanced growth come from? Largely the Federal Reserve’s QE 1-2-3 policies which provided liquidity, kept interest rates low and boosted asset prices.  This is also the challenge for 2014: whether or not the Fed begins its tapering after tomorrow’s FOMC meeting, or waits until sometime in 2014, some of the underpinning of the market is going away in the new year.

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

The Persistence of Non-Persistence

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Aye Soe

Managing Director, Global Head of Product Management

S&P Dow Jones Indices

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The phrase “past performance is not a guarantee of future results” has never rung more true for active mutual funds. Our semi-annual publication, the Persistence Scorecard, takes a look at the performance of top quartile active funds over three- and five-year consecutive 12-month periods. Based on the most recently released report, out of 265 large cap funds that were in the top quartile as of September 30 2011, only 5.28% (amounting to about 14 funds) remained in the top quartile at the end of September 2013. Only 10.31% of the funds managed to stay in the top quartile in the mid cap space while 8.28% of the small cap funds stayed in the top quartile. The breakdown of each fund category is highlighted in the table below.

Performance Persistence over Three Consecutive 12-Month Periods

Our study finds that performance persistence declined further over a longer-term five year horizon.  Only 3.95% of the large cap funds (amounting to approximately 10 funds) and 1.92% of small-cap funds (merely 3 funds) remained in the top quartile at the end of the study period.  It is worth noting that no mid cap funds managed to remain in the top quartile.

Performance Persistence over Three Consecutive 12-Month Periods

In short, the report is a sobering reminder that we cannot use the past performance figures as the sole or the most important criterion in fund selection.  In addition, the transition matrices in Report 4 and 5 suggest that a healthy percentage of top quartile funds in the subsequent period come from prior period second or third quartiles.

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