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Is Small The New Big?

Bonds Will Need to Tread Lightly With Domestic And Global Issues

Could VEQTOR Fail to Deliver?

Municipal Bonds: Hooked on Tobacco

Rising Inflation? That’s For Time To Decide

Is Small The New Big?

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Koel Ghosh

Head of South Asia

S&P Dow Jones Indices

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The recent launch of our S&P Dow Jones Indices India Index Dashboard brought to my notice the S&P BSE Small Cap Index. While the month’s report card was mostly green for the Indian indices due to the optimism in the Indian stock markets, the S&P BSE Small Cap Index did shine through.

  • The S&P BSE Small Cap Index returns as on May 30, 2014 was 54.36% (based on total return index) and 51.69% (based on price index). Further, the year to date return was 37.91% while it clocked in a one-month return of 20.41%.
  • During the one-year period ending May 30, 2014 the top 3 sectors attributing to this growth were Industrials, Materials and Consumer Discretionary.
  • The top contributors to the growth of the index in the one year ending May 30, 2014 were PMC Fincorp Limited and Sulabh Engineers & Services Ltd. Please see the list of top 10 below.
Security Name Stock Price Change (%) Stock Total Return (%) Contribution To Index Return
PMC Fincorp Limited 501.07% 501.66% 2.23%
Sulabh Engineers & Services Ltd. 212.82% 212.82% 1.41%
Risa International Ltd. 110.47% 110.47% 1.19%
Amtek Auto Limited 178.94% 179.95% 1.12%
Tilak Finance Limited 190.74% 190.74% 1.11%
CCL International Limited 275.42% 275.42% 1.05%
Kelvin Fincap Ltd. 254.49% 254.49% 1.02%
Sintex Industries Limited 329.37% 329.37% 0.95%
VA Tech Wabag Limited 155.53% 159.54% 0.95%
PTC India Limited 97.36% 97.36% 0.90%

Source: Asia Index Pvt. Ltd. Holdings Data as of S&P BSE Small Cap 31 May 2013 through 30 May 2014

If we compare the S&P BSE Small Cap Index with the benchmark S&P BSE SENSEX or even the broad market representative S&P BSE 500 for this one year period, the outperformance to both these broad market indices is clear.

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Source: Asia Index Private Limited, One year total return Performance for the period ending 30 May, 2014 

Indices One year Total Returns %
S&P BSE SMALL CAP (TR) 54.36%
S&P BSE SENSEX (TR) 24.04%
S&P BSE 500 (TR) 25.52%

Source: Asia Index Private Limited. One year returns for the one year period from 31 May 2013 to 30 May 2014 

S&P BSE Small Cap Index
Annualized Total Returns 54.37%
Annualized Standard Deviation 15.17%
Return per unit of risk 3.58

The S&P BSE Small Cap performance since inception has been 23.75% (Total return performance dated April 1, 2003 to May 30, 2014)

S&P BSE Small Cap Index is definitely displaying a new trend and one always needs to put this in perspective with the long term performance statistics to gain a better understanding of overall performance.

Capturing sector performance can be easily achieved through passive investing. Passive or index Investing allows investors to gain access to such index returns with very little effort and the ability to track the trends in the sector through its historical performance. In India, the trend of index investing is just about picking up with the existing offering of index funds and ETFs.

 

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

Bonds Will Need to Tread Lightly With Domestic And Global Issues

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Kevin Horan

Director, Fixed Income Indices

S&P Dow Jones Indices

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  • Last week saw the yield of the S&P/BGCantor Current 10 Year U.S. Treasury Bond Index close 1 basis point tighter than the 2.61% that started its week.  Thursday was the only day in which the yield moved significantly as yields tightened by 5 basis points in reaction to the weaker than expected Retail Sales release.  Treasury bond prices were stronger for the Monday opening as increasing tensions over the latest Iraq situation have bumped up demand for quality assets.  In reaction to the situation that has been steadily increasing, oil prices were the early mover as the S&P GSCI All Crude (TR) Index saw its largest year-to-date one day jump of 2.39% last Thursday and returned 4.21% for the week.  A full-on flight to safety trade has not started given the current political situation though with the suspected number of short market trades in place, if an unwinding trade were required it could have a quick and strong impact to rates.  Like the Ukraine crisis, investors wait and watch to see the level of involvement required by foreign governments.
  • In addition to keeping an eye on the Middle East, the forward U.S. economic calendar contains some key indicators.  Today kicked off with the Empire State Manufacturing Survey stronger than expected reporting 19.28 versus the expected 15.0.  Industrial Production month-over-month for May also was higher than the surveyed level of 0.5% at a 0.6%.  Though today’s manufacturing and production results were muted by an announcement by the IMF (International Monetary Fund) that its U.S. growth forecast had been cut.  Anticipation awaits the release of U.S. CPI on Tuesday which is expected to be a 0.2% month-over-month.  This indicator has been on the rise since February’s 0.10%.  Year-over-year is currently at 2% and if higher could indicate that inflation is accelerating faster than the Fed anticipated.  Housing Starts (1029k, expected) and Building Permits (1050k exp.) will also be released on Wednesday.  The end of the week has the largest potential to impact the markets as the Fed will conclude its meetings with its FOMC Rates Decision on Thursday.  This coupled with Friday’s Initial Jobless Claims (2600k, exp.), the Philly Fed Business Outlook (14 exp.) and May’s Leading Indicators Index (0.6% exp. vs. 0.4% prior) makes for a hectic week.
  • The S&P U.S. Issued High Yield Corporate Bond Index continued to outpace its investment grade counterpart by closing the week with a return of 0.25% for a year-to-date return of 5.15%.  New Issuance also continued at a healthy pace as issuance in names such as DaVita Healthcare, Ferrellgas, Gibson Energy, iStar Financial and Virgolino de Oliveira Finance came to market.
  • The investment grade segment of the corporate bond market also saw a significant number of new issue deals in household names such as Citigroup, Home Depot, John Deere, Johnson Controls and New York Life.  The S&P U.S. Issued Investment Grade Corporate Bond Index returned 0.11% for the week which helped whittle down the negative month-to-date return of -0.61%.  Year-to-date the index has returned a positive 4.86% though this is down from its end of May high of 5.64%.
  • Like investment grade corporate bonds, preferred securities have given up ground as well.  The S&P U.S. Preferred Stock Index’s (TR) year-to-date is down from its May month-end year-to-date high of 10.4% and has presently returned 9.73%.  For the week, preferred’s returned 0.04% but are still down -0.6% for the month.  The S&P 500 was also down for the week returning -0.63%, its first negative weekly return since May 9th.

Source: S&P Dow Jones Indices, Data as of 6/13/2014

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

Could VEQTOR Fail to Deliver?

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Berlinda Liu

Director, Global Research & Design

S&P Dow Jones Indices

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In my last post, I explained VEQTOR’s allocation process and purpose. Some suspicion rises about its relatively short back test history and even shorter live data. Let’s talk about its performance and discuss the scenario when it fails to deliver what it’s supposed to, that is, hedging downside risk.

VEQTOR was launched on November 18, 2009. While it didn’t live through the financial crisis, it did capture the 2011 US Treasury downgrade and has sustained the test.  From July 31, 2011 to September 30, 2011, the S&P 500 index lost 12.08% in only two months. In the meantime, VEQTOR rose 13.34%. Exhibit 1 shows the performance of the S&P 500 and VEQTOR in 2011. Before the downgrade news hit the market, they both peaked on 4/29/2011. The S&P 500 bottomed out with a maximum drawdown of -18.64% on 10/3/2011 and could not restore to its April peak value until 2012, while VEQTOR hit its bottom on 8/9/2011 with a maximum drawdown of -5.37% and bounced back to its April peak value in only 9 calendar days. At the end of the year, the 500 returned only 2.11% with a volatility of 23.37% and VEQTOR posted an annual return of 17.41% with a volatility of 10.78%.

Exhibit 1: S&P 500 and VEQTOR Performance in 2011

The reason that VEQTOR held strong in 2011 despite its short back test history is that this model is based on market statistics, not on data mining. When black swan events happen, VEQTOR frame work could fail only on two possible reasons: 1) the negative correlation between equity market and its volatility breaks; or 2) VEQTOR allocation process breaks, which essentially means that the implied volatility or realized volatility signal breaks. Due to short trading history of VIX futures, we are not able to extend VEQTOR’s back test data. But we can discuss realized volatility and implied volatility in a much longer time period.

VIX was launched on January 19, 1993. To minimize any suspicion on back test, we only investigated VIX’s behavior since its launch date. Our study shows that the correlation between VIX and the S&P 500 (since January 1993) is around -73%, on par with their correlation since December 20, 2005, VEQTOR’s inception date. We do not see this negative correlation breaking any time soon which is why the S&P 500 put options are generally used to hedge their downside risk. So the next question is: will the correlation between the equity market and the VIX futures market break? The VIX futures market may not move with VIX spot all the time due to its roll cost. However, that happens mostly when VIX is hovering at its lower end. When the market is in stress (and when VEQTOR is supposed to act to the stress), VIX futures tend to go up with the spot. Roll cost tend to be overwhelmed by the spot movement, and the futures curve may even flip into backwardation and generate positive roll yield. Exhibit 2 shows the 50 biggest daily drops of the S&P 500 index and corresponding returns in the VIX spot and futures (if applicable).

Exhibit 2: 50 Biggest Daily Drops of the S&P 500 and Responses in VIX Spot and Futures (1/19/1993 – 5/22/2014)

Exhibit 3: S&P 500 and VIX history (1/19/1993 – 5/22/2014)

How about the VEQTOR allocation process? Would it respond to the market turbulence if it existed since 1993? We applied the allocation algorithm (minus the stop-loss feature, which has to be derived from VEQTOR index values) on those post-tech-bubble years, and got this:

Exhibit 4: Hypothetical VEQTOR Allocation After Tech Bubble Burst (7/14/2000 – 11/26/2002)

It seems that, if VIX futures were traded during that period and VEQTOR back test history could be extended, VEQTOR would have increased its allocation to VIX futures accordingly, up to 40%. Provided that the volatility-equity negative correlation held over the long term and VEQTOR allocation worked this way, chance of VEQTOR not doing its job during post-tech-bubble period seems slim.

We know this period also covered Sept-11 event. The equity market was closed for a week. After trading resumed on 9/17/2011, the S&P 500 was down by 4.89% and VIX spot went up 31.16%. If we were able to extend VEQTOR history, VEQTOR would have quickly increased its allocation to VIX from 10% to 15% the next day, and to 25% three days later.

Finally, let’s take a look at VEQTOR’s performance since its launch date (Exhibit 5). As I pointed out earlier, the VEQTOR has underperformed the equity market for the majority of the time. However, that does not negate its use as a hedging tool for equity market tail risk. We shouldn’t judge a sushi chef by his ability of making curry chicken, should we?

Exhibit 5: Performance History (11/18/2014 – 5/22/2014)

Source: S&P Dow Jones Indices.  Chart is provided for illustrative purposes.  Past performance is not a guarantee of future results.

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

Municipal Bonds: Hooked on Tobacco

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J.R. Rieger

Head of Fixed Income Indices

S&P Dow Jones Indices

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The S&P Municipal Bond Tobacco Index has returned 12.79% year to date as the tobacco settlement bond market has recovered from a dismal 2013 return of -8.77%. Yields of these bonds have fallen 99bps during the year to an average of 5.92%. These long duration higher yielding bonds represent just under 15% of the total market value of the S&P Municipal Bond High Yield Index which has returned 9.86% year to date.

Yield investors seem to be willing to accept significant incremental risk over the near term as the prospects for repayment of tobacco settlement bonds is dependent upon tobacco sales in the U.S. which has been declining over time and may be a critical factor that may drive defaults of these bonds in the future.

The ten year range of the municipal bond market remains relatively cheap given the S&P AMT-Free Municipal Series 2023 Index has an average tax free yield of 2.53% which is just 5bps below the 10 year U.S. Treasury Bond.

Longer, high quality municipal bonds tracked in the S&P Municipal Bond 20 Year High Grade Index have returned over 12.2% year to date as yields have dropped by 79bps during the year so far.

Returns of Select Municipal Bond Indices as of June 12, 2014:Source: S&P Dow Jones Indices.  Data as of June 12, 2014.

Source: S&P Dow Jones Indices. Data as of June 12, 2014.

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

Rising Inflation? That’s For Time To Decide

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Kevin Horan

Director, Fixed Income Indices

S&P Dow Jones Indices

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With the volume of news headlines and the speed of information, tid bits of news, some with the potential to be significant, can naturally get lost in the shuffle. One such issue that might have some significance in the coming weeks is the president of the St. Louis Federal Reserve, James Bullard saying that there is evidence of inflation “moving higher”. This statement shows a change in Bullard’s view point. In the past, he has shown concern over the low levels of inflation and recently has commented on the stability of the inflation rate. As of April 30, the level of annual inflation is 2%.

The Consumer Price Index (CPI) is a widely recognized price measure used in the U.S. to track the price of a market basket of goods and services purchased by individuals. The weights of the components are based on consumer spending patterns. The next release of the CPI will be June 17 and the market’s survey is calling for a month-over-month value of 0.2%. The CPI value has been trending higher since February’s 0.10% as March and April were 0.2% and 0.26%, respectively.

Rising inflation expectations resulting from comments in the news and recent CPI results can be attibuted to the performance of Treasury Inflation Protections Securities (TIPS). The S&P U.S. TIPS Index, a broad, comprehensive, market value-weighted index seeks to measure the performance of the U.S. TIPS market. Year-to-date, the index is returning 5.37%. Longer maturity indices such as the S&P 15+ Year U.S. Treasury TIPS Index returned 16.64% (see table).

The last TIPS auction was May 28 an $13 billion of a reopened 10-year TIPS was issued. The initial market reaction to the auction was positive. Since May 28, the return of the 10-year TIPS has been +0.62% as measured by the S&P 10 Year U.S. TIPS Index. The next auction for 30-year TIPS will be on June 19th, a reopening of the existing 29-year, 8-month 1.375% of Feb. 2044, and the amount offered will be $7 billion.

Break-even inflation is the difference between the nominal yield on a fixed-rate investment and the real yield on an inflation-linked investment of similar maturity and credit quality. If inflation averages more than the break-even, the inflation-linked investment will outperform the fixed-rate. Conversely, if inflation averages below the break-even, the fixed-rate will outperform the inflation-linked. Presently the break-even inflation of the 10-year TIPS is at 2.40%. This means that if inflation averages more than 2.40% over the next 10 years, TIPS will outperform a traditional Treasury. Time will tell if the rate at which inflation is rising in the U.S. could become a problem for the Federal Reserve or investors.
Break-Even InflationSource: S&P Dow Jones Indices, June 11, 2014
Note: Though both indices measure 10 years they have not been duration matched.

TIPS Total Return Performance

 

 

 

 

 

 

 

 

 

 

 

 

 

Source: S&P Dow Jones Indices, June 11, 2014

 

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