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A Tale of Two Benchmarks: Factors

U.S. Treasuries' Wild Ride

Variety is the spice of life….and it’s essential for indices, too.

Have Bonds Been Painted Into A Corner?

House Prices and Incomes

A Tale of Two Benchmarks: Factors

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Phillip Brzenk

Senior Director, Strategy Indices

S&P Dow Jones Indices

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This is the third in a series of blog posts relating to the in depth analysis of performance differential between the S&P SmallCap 600 and the Russell 2000.

As we noted in the previous post, the reconstitution effect seen in the Russell 2000 doesn’t fully explain the differences in returns between the S&P SmallCap 600 and Russell 2000. Our analysis turns to factor testing, first using the Fama-French three-factor model, which includes the Market, Size and Value factors [1]. All three factors are statistically significant in explaining the index returns, though the S&P SmallCap 600 shows a statistically significant unexplained positive alpha (Intercept). The market factor is similar between the two indices, while the size and value factors differ. The size coefficient is larger in the 2000, leading to the conclusion that the Russell has more exposure to smaller capitalization companies. The 600 has a higher value factor coefficient, thus being tilted more towards value companies versus the 2000.

[1] Fama and French, 1993

A_Tale_of_Two_Benchmarks_Factors_1

With a statistically significant unexplained alpha present in the three-factor model for the 600, additional factors are added to the analysis with the introduction of two separate four-factor regressions models.

The first model incorporates the momentum factor (WML) first introduced by Mark Carhart [1], to the traditional Fama-French three-factor model. Momentum, the tendency for stocks to exhibit persistence in their relative performance, is a well-known anomaly in investing and gives sufficient reasoning to test its efficacy in explaining small-cap returns. As shown in the exhibit below, the momentum factor fails to add explanatory power to the three-factor model, with both coefficients near zero and both t-statistics insignificant.

[1] Carhart, 1997

A_Tale_of_Two_Benchmarks_Factors_2

The second model incorporates the quality factor (QMJ) first introduced in a paper by AQR, defined as companies that are profitable, growing and well managed [1]. The authors go on to mention that investing in high quality companies earns significant historical risk-adjusted returns. When the quality factor is added to the Fama-French model, interesting effects are seen in the output. In both indices, quality is positive, but the factor is larger for the S&P SmallCap 600 and statistically significant (it is not significant in the Russell 2000). In addition, the unexplained positive alpha of the S&P SmallCap 600 is no longer present- leading to believe that quality is a driving factor in the excess returns. Since profitability is a component of quality, the positive earnings screen implemented in the S&P Dow Jones Indices methodology could be seen as a contributor to the larger factor loading in the 600.

[1] Asness, Frazzini and Pedersen, 2014

A_Tale_of_Two_Benchmarks_Factors_3

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

U.S. Treasuries' Wild Ride

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Kevin Horan

Director, Fixed Income Indices

S&P Dow Jones Indices

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The past month was a wild ride for U.S. Treasuries, and April seems to be starting out the same.  The yield of the S&P/BGCantor Current 10 Year U.S. Treasury Index closed the half-day trading session for the Good Friday holiday (April 3, 2015) at 1.86%.  The yield is at a two-month low, as rates have bounced around since the 1.81% reached on Feb. 5, 2015.  Friday’s speculation that the Fed won’t be able to raise rates anytime soon came off the back of a slowdown in job growth, as measured by the Change in Nonfarm Payroll number, which was 126,000 versus the surveyed and expected 245,000.

Prior to Friday’s trading, the yield of this index had increased by 13 bps, reaching 2%, after a 1.87% monthly low on March 24, 2015.  This low had resulted from a rally down in yield (38 bps) after the monthly peak of 2.25% on March 6, 2015.  The return of the index as of the end of March was 0.76% MTD and 3.06% YTD, while in April, the index has returned 0.66% MTD and 3.74% YTD (as of April 3, 2015).

Exhibit 1: Index Yield to Worst

YTW History of the S&P-BGCantor Current 10 Year U.S. Treasury Bond Index

Source: S&P Dow Jones Indices LLC.  Data as of April 3, 2015.  Charts and tables are provided for illustrative purposes.  Past performance is no guarantee of future results.

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

Variety is the spice of life….and it’s essential for indices, too.

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Koel Ghosh

Head of South Asia

S&P Dow Jones Indices

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Recently, I seem to have gotten a bit addicted to online shopping, after experiencing the ease of online transactions and the constant exposure to multiple options.

Choice is important, and we are increasingly becoming spoiled by abundant choices in our everyday lives, be it with consumer goods or investments.  Online transactions are gaining popularity, not only due to their ease of execution, but also because of the convenience of being able to compare a varied number of options that meet one’s needs.  Furthermore, there is an increased awareness of new market entrants and ideas in the online space.  When there is a plethora of options from various sources, it becomes critical to be organized in order to evaluate them.  Hence, classification is essential.

This is applicable to financial market indices, as well.  There are multiple markets globally, with regional preferences and different rules and standards governing each one.  However, there are some common classifications that can be used to create comparable indices across regions. For example, every market does classify its components into large-cap, mid-cap and small-cap companies.  While the market itself could comprise various sizes based on regional capabilities, there seems to be standardization and a clear trend on how this classification is done.  The large-cap classification generally represents a significantly large percent of the total market capitalization, typically over 50%, followed by the mid-cap category, normally in the range of 10%-15%, and finally the small-cap label, which usually consists of a small percentage of total market cap.

Index classification is not only restricted to market capitalization—there are a number of other categories to choose from, as well.  Regional indices cover areas like the U.S., LATAM, APAC, EMEA, etc.  The regional offerings can be further defined into sub regions and countries.  There are sector indices offering other splits, like information technology, auto, banking and financials, manufacturing, etc., as there are many sectors that can prove useful to market participants and have a clear classification.  Additionally, there are an asset class-based index, which means there are either equity, fixed income, or commodities in the index universe.  While the aforementioned classifications are fairly generic for indices, there are also other classifications that offer access to a specific strategy or theme.  For example, S&P Dow Jones Indices has created the Shariah index series, which uses screening techniques to provide a variety of indices that are Shariah compliant, and this series is subdivided by region, as well.  In India, the S&P BSE 500 Shariah is the regional offering.  Themes such as asset allocation, dividends, etc. can also be used to classify indices.  Finally, custom indices can be created from standard classifications, offering another wide range of choices.

The classification of indices offers product providers the choice to create a range of offerings for investors.  Index providers are recognizing the need for choices and are creating innovative and varied options to suit market requirements.

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

Have Bonds Been Painted Into A Corner?

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Kevin Horan

Director, Fixed Income Indices

S&P Dow Jones Indices

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Lower yields and newly issued coupons have added an element of danger to fixed income investing.

The following chart shows that since September 2013, the weighted average coupon of the S&P U.S. Issued Investment Grade Corporate Bond Index has trended down, as higher-coupon bonds are called away and lower coupon new issuance is added to the index at the monthly rebalancing.  The result of a lower coupon for the index is that the modified duration has been moving up, or longer out on the curve.  The modified duration of the index is currently at 6.9 years, and the coupon is 4.35%.   The index has returned 0.41% MTD and 2.11% YTD as of March 31, 2015.

As issuance in the primary markets hits record levels, lower coupons, yields, and longer bonds could change the characteristics of an index.

  • The lower the bond’s coupon or yield, the higher the duration and volatility of price. Bonds with low coupon rates and lower yields will have a higher duration than bonds that pay high coupon rates or offer higher yields.  Because the bond pays a low coupon rate, the holder of the bond receives repayment of the bond at a slower rate.
  • Longer-maturity bonds also have higher durations and are exposed to more risk.
    Lower Coupon-Longer Duration

 

 

 

 

 

 

 

 
Source: S&P Dow Jones Indices LLC.  Data as of March 31, 2015.  Charts and tables are provided for illustrative purposes only.  Past performance is no guarantee of future results.

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

House Prices and Incomes

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David Blitzer

Managing Director and Chairman of the Index Committee

S&P Dow Jones Indices

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Since the S&P/Case-Shiller National Home Price index bottomed in December 2011, the national index is up 24% or 7.5% annually. While the Index is about 10% below the peak level set in July 2006, the indices for Denver and Dallas set new all-time peaks last year. Boston and Charlotte NC are both closing in on new record highs. The rise in home prices comes against a background of stagnant wages gains, raising worries that some people are at risk of being priced out of the home market.

houseincome1

The short term picture, shown in the first chart, may be cause for concern.  The chart compares the S&P/Case-Shiller National index with per capita personal income during 2012-2014.  Home prices rose steadily except for a brief pause in early 2014. Incomes also rose, but by 9% over three years, only one-third as much.  The spike in income at the end of 2012 reflects a one-time shift in the pattern of dividend payments caused by fears that the Congress would not renew their favorable tax treatment.

houseincome2

A longer view of the data tells a different story, as shown in the second chart. From 1975, when the S&P/Case-Shiller National Index starts to about 1990, home prices and per capita income tracked one-another quite closely.  In the early 1990s the combination of the 1990-91 recession followed by Fed tightening of monetary policy a few years later caused home prices to flatten out while incomes continued to rise. In the late 1990s the housing boom began to gather steam and home prices rapidly out-paced incomes (and much else). The dip in incomes and the collapse in home prices beginning in 2007 stand out, as does the recent faster growth in home prices.  With both house prices and incomes driven by the overall economy, a gradual convergence of the series is possible.  If home prices do outpace incomes, some potential home buyers will be priced out of the market and prices will slow or possible drop in response.

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