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China Bond Defaults and Indexing the China Bond Market

When Did Everyone Get so Sick?

Infrastructure Preferreds, +4.96% YTD

A Tale of Two Benchmarks: Factors

U.S. Treasuries' Wild Ride

China Bond Defaults and Indexing the China Bond Market

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J.R. Rieger

Head of Fixed Income Indices

S&P Dow Jones Indices

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The corporate bond default of Cloud Live Technology Group this week may be a bellwether moment for the Chinese bond markets.  So far, Beijing is allowing the default and not stepping in with a bailout of any kind, and that may be a signal the markets.  The recent Wall Street Journal article China Defaults Test Official’s Resolve by Dinny McMahon says that this could be
“a test of Beijing’s willingness to give market forces a greater role in the economy.”  The globalization of the Chinese bond markets is important for China, and doing so allows more free-flowing information, while bringing transparency of the bond markets toward global standards  will be be critical.

Independent and transparent bond indices play an important role as well.  Indices that use independent data sources and global indexing standards also help raise the level of information about the characteristics of opaque bond markets.

How does this default affect the China bond indices?

The Cloud Live Technology bond issue is a financing of about CNY 480million, a relatively small bond issue – so small it did not qualify for the rules-based broad benchmark S&P China Bond Index, which has a minimum par amount requirement of CNY 1 billion for inclusion.   The bond also did not qualify for inclusion in the S&P China Composite Select Bond Index which is a rules-based index designed to be replicable by passive investors.  To be replicable, due the depth and transparency of the corporate bond markets, the index intentionally excludes corporate bonds unless they are Central State-Owned Enterprises (CSOE’s).

We continue to keep a close eye on the evolution of the corporate bond markets in China; the more transparency and steps towards global standards may help open the market up to a broader global market.

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

When Did Everyone Get so Sick?

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Chris Bennett

Director, Index Investment Strategy

S&P Dow Jones Indices

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While the government squabbles over the future of healthcare, healthcare company executives can just sit back and smile.  Their investors can too.

In the U.S., the healthcare sector significantly outperformed broad parent indices in the first quarter 2015, across capitalization ranges.  On a total return basis, the S&P 500® Health Care sector index gained 6.5% in the first quarter, while the S&P 500 ended the quarter up 1%.  The S&P SmallCap 600® Health Care sector index led the pack, ending the quarter up over 15%, while the S&P SmallCap 600 gained 4%.

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The main benefactors in the U.S. have been mid- and small-cap pharmaceuticals.  The S&P MidCap 400 Pharmaceuticals industry index was up 44% in the first quarter, while the S&P SmallCap 600 Pharmaceuticals industry index was up 32%.  Biotechnology has cooled off slightly in 2015, following a very strong performance in 2014.

This trend is not limited to the United States, however.  Globally, the healthcare sector also outperformed broad market benchmarks.

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So what’s driving this outperformance?  Well for one, there has been significant M&A activity in the space, as consolidation seems to be the name of the game.

These data also imply that the market believes the healthcare sector will continue to be prosperous.  Flows into the space indicate confidence, while recent growth in biotechnology demonstrated that some past wounds have healed.  While we wait to see if these valuations are long on substance, we must ask: Are we all really that sick?

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

Infrastructure Preferreds, +4.96% YTD

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Kevin Horan

Director, Fixed Income Indices

S&P Dow Jones Indices

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Over a three-year period, the annualized returns of the U.S. preferred market have been more bond-like than equity-like.  The S&P U.S. Preferred Stock Index had a three-year annualized return of 7.95% as of March 27, 2015 while long U.S. Treasury bonds have returned 8.14% in the same period.  Meanwhile, the three-year annualized return of the S&P 500 has been well over 15%.  All of this is pointed out by J.R. Rieger in his recent blog post: U.S. Preferred Stock: Equity & Bond Characteristics Helping or Hurting Performance?

In order to address the growing interest in the infrastructure market, S&P Dow Jones Indices recently launched an index designed to track an additional segment of the preferred market: the S&P U.S. Preferred Infrastructure Stock Index.  The index has returned 0.03% MTD and 4.96% YTD on a total rate of return basis, as of April 2, 2015.  Returns for 2015 have all been positive at 3.37% (January), 1.11% (February), and 0.39% (March), while the dividend yield was 5.88% as of April 2, 2015.

As mentioned in J.R.’s post: “While it is easy to relate the performance of preferred stock and long-term bonds to interest rate changes, the two asset classes have shown a low correlation to each other over the last three years.  Actually, the S&P U.S. Preferred Stock Index has had a higher correlation to the S&P 500 than it did to long-term bonds.  There is a danger in just looking at the last three years, of course, as interest rates have been held low during the period.”

Below are three visuals.  The first reports on the three-year correlation across four index types, while the second shows the returns of the S&P U.S. Preferred Infrastructure Stock Index.  The graphic that concludes this piece reports on the historical total returns of U.S. preferred infrastructure stocks.
Exhibit-1: Three-Year Correlation Across Indices

 

Exhibit-2: S&P U.S. Preferred Infrastructure Stock Index

 

Exhibit-3; Historical Returns of S&P U.S. Preferred Stock IndexSource: S&P Dow Jones Indices, LLC.  Data as of April 2, 2015.  Past performance is no guarantee of future results.  Charts and tables are provided for illustrative purposes and may reflect hypothetical historical performance.  Please see the Performance Disclosures at the end of this document for more information regarding the inherent limitations associated with back-tested performance.

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

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.