Indexology^® Blog

The green credit market has grown 50% annually since 2007, however market sentiment remains mixed on performance.  The S&P Green Bond Index is down 0.99% YTD, when most of the bond market has done quite well in 2014.  Abundant growth in concert with poor performance could prompt the suggestion that investors are deriving utility from social responsibility in lieu of returns.

Abengoa Greenfield’s equity shares fell 18%, while the price of their 2021 notes fell from $96 to $83 Thursday, following market confusion about the recourse status of the Spanish clean energy firm’s “guaranteed” debt.  Abengoa comprises 2.5% of the S&P Green Bond Index which fell 0.11% yesterday.  This type of volatility is somewhat of an anomaly for the budding market, with the majority of the index being comprised of extremely high rated supranational debt.  The S&P/BGCantor U.S. Treasury Bond Index is up 3.06% in 2014, surpassing its five year annualized return of 2.86%.

The S&P Green Project Bond Index is up 8.85% YTD however, outperforming the S&P Municipal Bond Index which is up 8.27% YTD.  Green project bonds finance specific environmentally friendly projects, creating more risk and return in the current low rate environment.  Green project bonds have also outpaced high yield corporates by nearly 95%, as the S&P U.S. Issued Corporate Bonds Index is up 4.56% YTD.

The green bond universe is still vastly made up of supranational organizations and performs accordingly, however as segments within the market continue to develop, green bonds are beginning to show their true colors.

Now that brent broke the $80 mark, many are questioning whether a bottom has been reached.  The combination of slowing Chinese demand growth and Saudi’s will to maintain market share make this an unlikely bottom, but it depends more on the supply growth than the slowing demand growth from China.

Kuwait and Saudi Arabia have shown signs they are willing to tolerate lower prices.  If prices continue to drop significantly, there may be not only a pickup in demand but a split where regions that are less heavily reliant on exports like in Africa and Asia may accelerate compared with a more pronounced slowdown from areas like S. America that depend on oil exports for their demand growth. The IEA predicts an acceleration of up to 2.6%, up 800 kb/d, led by Asia, Africa and the Middle East that will overpower slower growth from sanctions-hit Russia.

While oil would need to drop below $40 to seriously hinder US production, it only needs to hit below $70 to impact weaker marginal oil producing countries Brazil and like Russia – or even put OPEC into a panic.  I was asked if this could happen in a Sky interview, and it is possible oil could slide another 50%.

In a NYT Op-Ed, it was pointed out from a prior article that “there is a precedent [for] such joint action that caused the collapse of the U.S.S.R. In 1985, the Kingdom dramatically increased oil production from 2 million to 10 million barrels per day, dropping the price from $32 to $10 per barrel. [The] U.S.S.R. began selling some batches at an even lower price, about $6 per barrel. Saudi Arabia [did not lose] anything, because when prices fell by 3.5 times [Saudi] production increased fivefold. The planned economy of the Soviet Union was not able to cope with falling export revenues, and this was one of the reasons for the collapse of the U.S.S.R.”

However, the slide in oil prices may stimulate the economy. In a separate Reuters interview, I was asked whether we might see gas below $2 since that may help stimulate the economy driven by the retail consumer.  We would probably need to see oil slide another 50% in order for this to happen, given the last time gas prices were that low was in 2009, post the financial crisis. (See in the chart below).  That could happen if Saudi really wants to destroy other oil producers in spite of itself, just like it cut prices by more than half in the 80’s.

Real estate, once the villain of the financial crisis, is now lauded as the place to find yield, diversification and maybe stability.  Before REITs became eligible for the S&P 500 in October 2001, real estate investing either meant direct ownership or a specialized corner of the stock market.   The recovery from the financial crisis focused attention on real estate and REITs to understand what happened and why.  With equity markets at record highs and yields and interest rates at record lows, the search for yield is focusing attention on REITs and real estate companies.

Recognizing the growing importance of real estate to investors, S&P Dow Jones Indices and MSCI announced on November 10^th that real estate would become a separate sector in GICS­­^®, the Global Industry Classification Standard.  Real Estate, previously part of the GICS financial sector, will be the 11^th sector while the financials will now be limited to financial services such as banking, insurance or exchanges.  This is the first time since GICS was launched in 1999 that a new sector is being added.  It is not the first change – when GICS was launched a commitment was made to maintain the classifications and update the structure to keep it consistent with the financial markets.

Introducing a new sector for real estate means increased attention to real estate as investors analyze markets and their own asset allocation.  It also means revisions to numerous databases and analytical systems which utilize GICS.  Raising the profile of REITs and real estate management and development companies is likely to encourage the development of new investment products focused on the asset class. Since new analyses and revising databases takes time, the implementation of the new sector will be in August, 2016.  While smaller GICS changes in the past – such as redefining an industry – were usually done with lead times of six to 12 months, comments from clients and investors suggested a longer than usual lead time.

While S&P Dow Jones Indices, together with MSCI, maintains GICS, we do not make decisions about changes in a vacuum.  The key part of the annual GICS structure review is consulting with clients and investors through face to face discussions, emails and web-based survey.  The consultation on Real Estate and REITs revealed that a substantial majority of investors treat real estate as its own asset class. Moreover, this is true in markets globally.  It is no surprise that more and more countries are introducing REIT structures into their tax codes and real estate finance.  Likewise, it is no surprise that REITs and other real estate securities are attractive based on yield.

Adding a new sector to GICS is the largest change in the structure since GICS began; it is also the latest step in industry classifications that go back to the 1920s and Standard Statistics Corporation’s (one of S&P Dow Jones’ predecessors) first index to classify stocks into industries.  That history explains why industry classification must change with the market: among those industries that no longer stand alone are cigar manufacturing, radio and phonograph and leather.

Details on the changes to GICS can be found HERE or HERE

According to the Dow Jones Sukuk Index, the new issues that being captured in 2014 YTD totaled USD 11.8 billion, which represents 26% of the index exposure. While the total size of new issues this year is largely in-line with 2013, there are few interesting issuance trends that we observed.

First, the average outstanding par of new issues tracked by the index, is on a rising trend and approaching USD 1 billion, as shown in Exhibit 1. This increase in deal size reflected a stronger investor demand. In fact, some returning issuers such as IDB Trust and Saudi Electric came back to the sukuk market with a larger deal size as well.

Exhibit 1: The Average Outstanding Par of New Issues in the Dow Jones Sukuk Index

Second, the issuing tenor is extending into longer maturities. While historically sukuk was mostly five-year deals, more ten- and 30-year issuances are now tapping into the market, please see Exhibit 2. And if we look at the current overall index exposure, 32% of the total outstanding par amount was issued with the tenor of ten-year or above.

Exhibit 2: The Number of New Issues vs. Issuing Tenor in the Dow Jones Sukuk Index

Last but not least, we continue to see emergence of new issuers in the sukuk market. For example, HK Government and South Africa Sovereign both recently issued a five-year deal, while Goldman Sachs also raised a $500mio for a five-year sukuk in the same period.

Want to find out more information about the Dow Jones Sukuk Index? Please click here.

There is an axiom among the capital markets desks of investment banks that goes something like this: “if you’re not in the loans then you’re not getting the bonds”.

The reasoning behind this statement is this: Other than fallen angels, the issuers of high yield debt are companies whose access to capital can be limited.  Start-up companies, whose story resonates with bankers, need to build relationships with lenders or existing companies whose line of business is highly leveraged.

For this reasoning, there is a significant amount of overlap between the issuers of leveraged loans and high yield paper. In a recent article, Invesco Fund Treads Risky Path as Major Investor in Distressed Corporate Debt, it is mentioned that Invesco PowerShares’s BKLN has major exposures to companies with weak balance sheets. However, an aspect of leveraged loans that was not developed in this article is that the loans are secured by the assets of the operating company and the terms are usually superior to those of high-yield bonds, which are generally unsecured.

Also a benefit to the senior loan structures is that loans are floating-rate instruments, which have coupon resets periodically with the prevailing benchmark for the interest rate (i.e., LIBOR).  Why is this important?  All things being equal, a rising interest rate environment will generally result in higher interest payments for those holding senior bank loans while not significantly impacting loan prices.   If or when a credit event does occur with a loan, the recovery rates on bank loans are 86%, much higher than the recovery rates secured, unsecured or subordinated bonds.

The issuers in the S&P/LSTA U.S. Leveraged Loan 100 Index are the same issuers in the S&P U.S. High Yield Corporate Bond Index. Currently the S&P/LSTA U.S. Leveraged Loan 100 Index has returned 0.12% MTD and 2.20% YTD while the S&P U.S. High Yield Corporate Bond Index has returned -0.20% MTD and 4.78% YTD.

Source: S&P Dow Jones Indices, data as of 11/07/2014