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Home Price Bricks in Your Portfolio

Leverage Loan Redemptions = Record Trading Volume + Market Depth?

The Rieger Report: Should Municipal Bonds be "Core"?

A Sweet Spot in Commodities

Inside The Dow

Home Price Bricks in Your Portfolio

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Marya Alsati

Product Manager, Commodities, Home Prices, and Real Assets

S&P Dow Jones Indices

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In this post, we look at whether adding a home price index, as part of a multi-asset bundle, to a hypothetical portfolio could potentially improve its attributes. We created two portfolios, one comprised of equities and bonds (portfolio A), and a second that contained the elements of portfolio A plus commodities, home prices and infrastructure (portfolio B). We found that the undiversified portfolio A performed better, while the diversified portfolio B had a lower risk attribute during shorter time periods. The two portfolios converged over the long run.

Exhibit 1 shows the weight distribution of the indices in each hypothetical portfolio.

Diversification_Exhibit1

In the short run, the performance of portfolio A outperformed portfolio B. In fact, during the 12-year period, on a monthly basis, portfolio A outperformed portfolio B 56% of the time. Interestingly, the two portfolios had similar maximum gains and declines, and they also showed similar average returns, as shown in Exhibit 2.

Diversification_Exhibit2

It can be seen from Exhibit 3 that in the long run, the two portfolios converged in terms of risk and returns. However, in the short run, higher returns could be obtained using the undiversified portfolio and lower risk in the diversified portfolio. Note that these results would vary if the weighting scheme and indices used change.

Diversification_Exhibit3

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

Leverage Loan Redemptions = Record Trading Volume + Market Depth?

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Tyler Cling

Senior Manager, Fixed Income Indices

S&P Dow Jones Indices

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With the majority of the fixed income world taking sides on prize fights like Greece, the European Central Bank (ECB), inflation, and energy-related debt, you may have missed the beating leveraged loans have been receiving in the media.

The Financial Industry Regulatory Authority (FINRA) cited senior loan liquidity concerns in their January letter, stating “…these loans could face liquidity challenges if a significant number of investors make redemption requests at the same time.” Forbes published an article last week observing outflows in the bank loan market 39 of the last 40 weeks, totaling USD 25.9 billion in redemptions from the asset class. How did loans fair in the redemption ring?

Leverage_Loan_Redemptions_Figure1

The Loan Syndications & Trading Association (LSTA) saw bank loan trading volumes increase 21.5% in 2014, to a record $628 billion, from the previous year (Exhibit 1). The LSTA also observed record market depth in the fourth quarter of 2014. In Q4 2014, over 54% of the 1,750 loan facilities traded, traded 20 times or more (see Exhibit 2).

Leverage_Loan_Redemptions_Figure2

While we all know past performance is not indicative of future performance, in times of record redemptions, why is the dialogue focused on liquidity concerns versus liquidity metrics? It is also worth noting that during the final nine months of 2014, bank loan mutual funds were able to meet over USD 28 billion redemption requests in every single case.

The S&P/LSTA Leveraged Loan 100 Index, which seeks to track the largest loan facilities, has been less volatile than the S&P U.S. Issued High Yield Corporate Bond Index over the past five years and it has achieved comparable risk-adjusted returns. Yields are also higher for the S&P U.S. Issued High Yield Corporate Bond Index than for the S&P/LSTA Leveraged Loan 100 Index (6.5% versus 5.05%, respectively), implying that market participants are willing to hold bank loans for less of an interest return than high-yield corporate debt.

Leverage_Loan_Redemptions_Figure3

With all credit, liquidity concerns for bank loans are real, but they should be viewed relative to the fixed income marketplace. The leverage loan bout might just be back-page news because it is lacking the glass jaw worthy of the K.O. headlines monopolizing page one.

Leverage_Loan_Redemptions_Figure4

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

The Rieger Report: Should Municipal Bonds be "Core"?

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J.R. Rieger

Head of Fixed Income Indices

S&P Dow Jones Indices

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The often misunderstood municipal bond market is not considered a ‘core’ asset class by many investors and institutions offering financial products to investors.  Certainly investment grade municipal bonds have some qualifications to be ‘core’ and the proposed Qualified Public Infrastructure Bond (QPIB) might help change the way we think about this important asset class.

Some things for us to consider:

  • High quality.  The average rating (Moody’s, S&P and or Fitch) of bonds in the S&P National AMT-Free Municipal Bond Index is higher than the average rating of bonds in the S&P U.S. Issued Investment Grade Corporate Bond Index.
  • Low default rate.  According to our research (Rieger & Cling: 2015), the 2014 12 month trailing default rate for municipal bonds was 0.17% (by number of defaults vs. # of bond deals outstanding).  I would be hard pressed to find another U.S. bond asset class beyond U.S. Treasuries that had a lower a default rate.
  • Duration.  It is a common assumption that municipal bonds are longer in duration than corporate bonds.  Currently the duration of the S&P National AMT-Free Municipal Bond Index (tracking only investment grade bonds) is 2 years shorter in duration than the duration of the S&P U.S. Issued Investment Grade Corporate Bond Index.  All else being equal, shorter duration means lower price movement up and down when rates rise and fall.
  • Yield.  The nominal yield of tax-exempt municipal bonds is indeed lower than corporate bonds.  However, when looked at from the perspective of how much return an investor actually keeps after taxes the story is different.  The taxable equivalent yield of municipal bonds is very competitive to taxable bonds.
  • Not only for the wealthy.  In the current high tax environment we are in tax-exempt municipal bonds can be considered an option for many investors and not just the wealthy or the top 1%.
  • Liquidity.  U.S. municipal bonds are indeed less liquid than their corporate bond counterparts.  Most municipal bonds are smaller in par amount than corporate bonds and there are many more municipal bonds brought to market. However, investment grade municipal bonds are far from illiquid.  During the 12 month period ending November 2014 an average of 68% of the over 9,500 bonds in the S&P National AMT-Free Municipal Bond Index traded each month!  The average trade size during that period of time:  over $265,000.
  • Public good.  U.S. municipal bonds serve as an important infrastructure funding source.  Roads, highways, bridges, tunnels, airports, ports, schools and so much more are built and maintained because they are funded by bonds.
  • QPIB. The recent proposal by President Obama to create a new type of bond called a Qualified Public Infrastructure Bond (QPIB) is intended to bolster the issuance of bonds to help maintain U.S. infrastructure.  This proposal must pass a republican congress and it is not the administrations first attempt at funding infrastructure development.  However, we all can see the degradation of our infrastructure.  Considering investment grade municipal bonds as a ‘core’ asset class might help this program and the use of other municipal bond issues make a difference.

References cited:

Rieger, James & Cling T.  January 2015 Fixed Income Update: The U.S. Municipal Bond Default Rate Hits 3-Year High in 2014: 0.17%

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

A Sweet Spot in Commodities

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Jodie Gunzberg

Managing Director, Head of U.S. Equities

S&P Dow Jones Indices

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It has been a rough start for commodities in 2015 with only six (natural gas, aluminum, lead, sugar, gold and silver) posting gains so far. At our commodities seminar in London last Sept, our speakers agreed picking a winner in this environment is diificult. However, it looks like one of our panelists may have done the job and picked “long sugar” as his best guess.

It is possible he based his guess on fundamentals that indicate rebalancing is often a source of return in commodity investing  where mean reversion works by capturing systematic opportunities.  In 2014, sugar lost 30.9% with a peak to trough drawdown from March through Dec., ending the year with a 1.8% weight in the world-production weighted S&P GSCI.

As of the close yesterday, Jan. 21, 2015, sugar’s weight had increased to 2.2% (18.7% growth) with a YTD return of 9.64%. It is the best month for sugar since Feb. 2014 and the last time we saw a January this sweet for sugar was in 2010 when it posted an 11.0% gain.

Source: S&P Dow Jones Indices. Past performance is not an indication of future results.
Source: S&P Dow Jones Indices. Past performance is not an indication of future results.

According to a Reuter’s article, sugar is rising after the Brazilian government restored a fuel tax on gasoline and diesel that is likely to encourage Brazil to produce more ethanol biofuel from sugar. It has also been reported that India is considering higher subsidies for raw sugar exports to cut large stockpiles.

It is possible these interventions may be what sweetens sugar’s term structure given there hasn’t been significant shortages indicated by backwardation (adding more than 1% to the excess return) since June 2012.

Source: S&P Dow Jones Indices. Past performance is not an indication of future results.
Source: S&P Dow Jones Indices. Past performance is not an indication of future results.

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

Inside The Dow

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David Blitzer

Managing Director and Chairman of the Index Committee

S&P Dow Jones Indices

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The Dow Jones Industrial Average is the best-known stock market measure. It has the longest continuous and consistent history of any market average or index and is still going strong today. There is more to the Dow than its long history and the historic record – it is a widely followed guide to the market and a key measure of large blue chip companies in the United States. It is on web sites and television news and is carried every day in the Wall Street Journal and many other newspapers. The Dow was created by the editors of the Wall Street Journal in 1896, a few years after the Journal itself began publishing. Today it is maintained and calculated by S&P Dow Jones Indices and overseen by the Averages Committee; both S&P Dow Jones Indices and the Wall Street Journal are represented on the committee.

The Dow and the S&P 500 both chronicle the US market and tell similar stories. The chart shows the two indices from April, 1957 to December 2014.  The figure starts in 1957 because that is when the S&P 500, a comparative newcomer, expanded from 90 to 500 stocks. The Dow has been 30 stocks since 1928; it began with 12 stocks in 1896.  The correlation of monthly returns is 95.4%, confirming the close tracking. In the 692 months from May 1957 to December 2014, the two indices rose, or fell, together in 627 months. The close tracking should not be a surprise. The overall stock market often reacts to large shifts in the economy or changes in Fed policy.  Moreover, the 30 stocks in the Dow account for slightly more than one-quarter of the S&P 500’s $19 trillion dollar market value.

Despite the close tracking between the Dow and the S&P 500, the calculation method is different. The Dow is a price weighted index; the calculation is simple enough to do with a pencil and paper in a few minutes. To calculate the Dow, add up the price of each stock and divide by the divisor, currently about 0.155. The divisor is adjusted whenever a stock is added or dropped to prevent the index from jumping or falling when the market didn’t. Corporate actions that affect a stock price, such as a stock split, also lead to a divisor change. The easiest way to think about the Dow is a portfolio which holds one share of each of the 30 stocks.  The importance of a stock depends on its price, not on the stock’s total market value. While some argue that this is the wrong way to measure the market, it may actually be close to the way many investors think of their own portfolios. Rarely do investors owning individual stocks try to make their relative size of their holdings track the market capitalization proportions of the companies they own. More often they try to hold either equal dollar amounts or equal numbers of shares in various companies.

Source: www.DJAverages.com, S&P Dow Jones Indices.

Next: Arguing that Apple and Google should be in the Dow, but don’t fit.

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