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Sector Dispersion and Active Management

Introducing the S&P Dow Jones Indices Versus Active (SPIVA®) Latin America Scorecard

China Bond Defaults and Indexing the China Bond Market

When Did Everyone Get so Sick?

Infrastructure Preferreds, +4.96% YTD

Sector Dispersion and Active Management

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Craig Lazzara

Former Managing Director, Index Investment Strategy

S&P Dow Jones Indices

Market volatility is a function of both dispersion and correlation, as shown in this schematic:

Dispersion and correlation 2Dispersion measures the degree to which the components of an index perform similarly.  If the components are tightly bunched, dispersion will be low and, other things equal, the index’s volatility will be low.  Correlation is a measure of timing; it measures the tendency of index components to rise or fall at the same time.  If the components tend to move together, correlation will be relatively high, and volatility will rise.  If component moves tend to offset, correlation and volatility will be lower.  In terms of our simple schematic, the farther from the origin an index is, the higher its volatility will be.

Dispersion, correlation, and volatility can be measured at the market index level, of course, but can equally well be measured at a finer level of granularity.  Below we’ve graphed these metrics for each of the 10 sectors of the S&P 500:

S&P 500 sector dispersion and correlationWe immediately notice that the highest volatility sectors tend to be the farthest from the origin and the lowest volatility sectors the closest — confirming our intuition about the interaction of dispersion and correlation.  But these data — ironically, perhaps, derived entirely from passive benchmarks — can also provide some useful guidance for active investors.

First, since dispersion measures the potential benefit of stock selection, an active stock picker might wish to concentrate his efforts on high-dispersion sectors.  There is, e.g., more potential benefit to choosing among technology stocks than among energy companies or utilities.  If analytic resources are scarce, in fact, there’s an argument to be made for simply indexing the low-dispersion sectors.  (We know at least one major institutional investor which does exactly that.)

Second, the nature of the most relevant analytic input differs across sectors.  For low-dispersion, high-correlation sectors, the most important decision is the sector call, not individual stock recommendations.  The returns of the constituents of these sectors tend to cluster relatively tightly, so stock selection is of relatively little value.  On the other hand, where correlations are high, it means that most stocks in the sector move up and down together.  A correct sector call will be reflected more consistently across all sector components.

An analyst who follows utilities or energy would be well advised to spend most of his time and effort deciding whether to be in or out of the sector.  An analyst who follows technology or healthcare may be better off trying to separate the sectoral wheat from the sectoral chaff.  Dispersion and correlation not only provide insight into the volatility of sector returns, but offer guidance for active analysts as well.

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

Introducing the S&P Dow Jones Indices Versus Active (SPIVA®) Latin America Scorecard

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Phillip Brzenk

Managing Director, Global Head of Multi-Asset Indices

S&P Dow Jones Indices

S&P Dow Jones Indices is proud to expand the SPIVA Scorecard report to the Latin America region.  The SPIVA methodology is designed to provide an accurate and objective apples-to-apples comparison of active funds’ performance versus their appropriate style benchmark indices.  The SPIVA Latin America Scorecard covers the Brazilian, Chilean, and Mexican markets.  A summary of the year-end 2014 results in the three markets follows.

Brazil
Actively managed Brazilian funds underperformed their category’s benchmark in all five fund categories in 2014.  In the Brazil Equity category, 50.36%of managers underperformed the S&P Brazil BMI for the year.  Managers focusing on a particular size segment did not fare favorably, with 72.92% underperforming in the Brazil Large-Cap Equity category and 69.77% underperforming in the Brazil Mid/Small-Cap Equity category.  In the fixed income categories, active managers overwhelmingly underperformed their benchmarks: 83.52% of managers in the Brazil Corporate Bond category and 82.95% in the Brazil Government Bond category underperformed their respective benchmarks in 2014.  Similar underperformance for all five categories was seen over the three- and five-year periods.

Chile
A slight majority (53%) of active equity fund managers in Chile were able to outperform the benchmark in 2014.  The short-term success of the managers is in stark contrast to their long-term returns, with less than 3% of active managers outperforming the benchmark over a five-year period.

Mexico
Mexican equity active managers were unsuccessful in outperforming the benchmark, with 73.33% of managers lagging the S&P Mexico BMI in 2014.  Likewise, 60.53% and 80.56% of managers underperformed the benchmark over the three- and five-year periods, respectively.

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

China Bond Defaults and Indexing the China Bond Market

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J.R. Rieger

Former Head of Fixed Income Indices

S&P Dow Jones Indices

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

Former Director, Index Investment Strategy

S&P Dow Jones Indices

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

Former Director, Fixed Income Indices

S&P Dow Jones Indices

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.