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A Big Step Forward for Saudi Arabia’s Equity Market

What are the Missing Pieces in Chinese Fixed Income?

Asia Fixed Income: Foreign Investor Access to Onshore Chinese Bond Markets Grows

The Essence of VIX: What You Really Need to Know

SPIVA® Europe Scorecard 2014: How did active funds perform versus their benchmarks?

A Big Step Forward for Saudi Arabia’s Equity Market

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Michael Orzano

Senior Director, Global Equity Indices

S&P Dow Jones Indices

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On May 4, 2015, the Saudi Arabian Capital Market Authority (CMA) released the “Rules for Qualified Foreign Institutions Investment in Listed Shares,” or the QFI program, setting the stage for institutional investors based outside of the Gulf Cooperation Council (GCC) to make direct investments in Saudi Arabian equities for the first time.  Although additional steps will need to be taken to further improve market accessibility in the future, the QFI program is a key step in the development of Saudi Arabia’s equity market.

The QFI rules, which are expected to become effective on June 1, 2015, require institutions to register with the CMA and meet certain qualifications based on assets under management and experience in the financial services industry.  In aggregate, all QFIs will be allowed to own a maximum of 20% of any listed company and a single QFI will be limited to a 5% stake in a single company.

Without a doubt, the QFI program marks a historic moment for Saudi Arabia’s capital markets.  Anticipation surrounding the opening of the Saudi Arabian market to foreigners has buoyed the country’s equity market over the past few years, despite a significant drop in the second half of 2014 driven by the plunge in oil prices.  As of April 30, 2015, the S&P Saudi Arabia had an annualized return of 11.3% over the past three years, widely outperforming the 2.4% return of the S&P Emerging BMI and even beating the 10.8% return of the S&P 500®.

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S&P Dow Jones Indices calculates and publishes more indices than any other provider for the Saudi Arabian market and throughout the GCC.  Through our acquisition of the International Finance Corporation (IFC) Indices in 2000, we have been calculating Saudi Arabian equity indices since 1997.

In addition to our flagship S&P Saudi Arabia Index, we publish various size, sector, and industry subindices that are designed to measure different segments of the market.  We also publish blue-chip indices, such as the Dow Jones Saudi Titans 30 Index, that are designed to support index-based financial products.  We also provide multiple versions of various indices reflecting the differing opportunity sets available to domestic Saudi Arabian investors and GCC nationals due to foreign investment restrictions.

 

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

What are the Missing Pieces in Chinese Fixed Income?

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Michele Leung

Director, Fixed Income Indices

S&P Dow Jones Indices

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As of April 30, 2015, the fixed income ETF market in China totaled CNY 8 billion; it is only 0.03% of the total market value tracked by the S&P China Bond Index.  The fixed income ETF market in China is small when comparing with that of the U.S., which totaled USD 321 billion as of the same date.

Unsurprisingly, most Chinese investors favor high-risk and high-return products.  They tend not to find the fixed income assets appealing, especially after the recent China stock rally.  However, Chinese investors often overlook the risk component.  As of April 30, 2015, the three-year annualized risk of China’s equity market1 is 19.5% versus 2.77% of Chinese fixed income, represented by the S&P China Bond Index.

Despite the differences in the regulatory landscape and product demand, we believe the China ETF market could learn from the growth seen in the U.S. ETF market as follows:

  1. Investor Education: Fixed income is considered a core asset class in the U.S.  It diversifies portfolio risk and plays an important role in asset allocation.  In order to build up retail investor participation in ETFs, Chinese investors should also learn about why and how they would be benefited from ETFs and passive investing, including cost effectiveness, flexibility, and diversification.
  2. Product Variety: Compared with the limited product types in China, the U.S. has a robust suite of product offerings, including sovereign bonds, corporate bonds, municipal bonds, inflation-linked bonds, convertible bonds, etc.  There is a strong growth potential for both the number and the type of fixed income ETFs in China in the coming years.
  3. Usage of ETFs: ETFs can not only be used for exposures and hedging tools, they can also be used as building blocks for strategic asset allocation or liquid instruments for tactical positions.  However, this is dependent on further improvements in underlying liquidity.
  4. Fixed Income Index (Benchmark) Practices:  The International Organization of Securities Commissions (IOSCO) publishes the Principles for Financial Benchmarks.  It is essential for an index provider to adopt  governance practices that address conflicts of interest and promote transparency.  Meeting investor demand and building investor confidence are  essential to the development of the ETF market.

1China equity is represented by the S&P Total China BMI (USD).

 

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

Asia Fixed Income: Foreign Investor Access to Onshore Chinese Bond Markets Grows

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Michele Leung

Director, Fixed Income Indices

S&P Dow Jones Indices

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China continues to broaden foreign investor access to their onshore bond market. Luxembourg is the latest country being granted an RQFII quota by the People’s Bank of China, followed Canada, Germany, Qatar and Australia.  According to the data published by State Administration of Foreign Exchange (SAFE) on April 29, 2015, the approved RQFII investment quota reached CNY 363 billion, representing a 22% increase from December, 2014. The number of the qualified institutions also rose from 93 to 121.

Among the qualified participants, Hong Kong remains to be the biggest player, with an RQFII quota allocation of around 74%, see exhibit 1 for the country breakdown. Outside of Hong Kong, the most significant development observed was by South Korea, with its approved quota jumping 10 times to CNY 30 billion, while the number of the qualified institutions climbed from 1 to 14 since last December.

In sync with the opening up of its capital markets, the China onshore market has recorded substantial growth in recent years. Tracked by the S&P China Bond Index, the market value of the China onshore bond market reached CNY 28 trillion, as of April 30, 2015. This market has expanded 22% since last year and more than three times since the index first valued on December 29, 2006. The market value tracked by the S&P Japan Bond Index, representing the other giant market in Asia, gained 2.6% and 37% respectively.

In terms of total return performance, the S&P China Bond Index rose 2.14% year-to-date (YTD), after a 10% gain in 2014.  Global investors seem to continue to favor Chinese bonds as they offer relatively higher yields as compared to markets globally. The index’s yield-to-maturity currently stands at 3.91%, compared with 0.27% yield-to-maturity from the S&P Japan Bond Index. Please see exhibit 2 for indices comparison.

Exhibit 1: Country Breakdown of the Approved RQFII quota from State Administration of Foreign Exchange (SAFE)

Source: State Administration of Foreign Exchange. Data as of April 28, 2015
Source: State Administration of Foreign Exchange. Data as of April 28, 2015

Exhibit 2: Indices Comparison

 S&P China Bond Index  S&P Japan Bond Index
 Calculated Currency  CNY  JPY
 Market Value  7,866,324,806,704  1,119,159,373,390,670
 Yield-to-Maturity  3.907%  0.273%
 1-Year Total Return  9.262%  2.475%

Source: S&P Dow Jones Indices. Data as of April 30, 2015

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

The Essence of VIX: What You Really Need to Know

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Reid Steadman

Managing Director, Global Head of ESG

S&P Dow Jones Indices

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What is the essence of VIX? This may seem like an abstract, philosophical question, but I can assure you it is not. It is a practical one, and if you can understand what makes VIX unique, you will know why this index matters so much.

Informed investors know that VIX:

  • Employs a wide range of options in its calculation, both calls and puts;
  • Maintains a constant 30-day maturity;
  • Is not based on an options pricing model such as Black-Scholes; and
  • Does not incorporate the S&P 500 price level in its calculation (VIX is negatively correlated to the S&P 500, but correlation does not translate to direct causation).

For most people, VIX is largely associated with the first two bullet points. But many indices use options prices and target certain maturities. The key attribute of VIX – the knowledge you need to take away from this post – comes from the final two bullet points. It has to do with how VIX measures implied volatility, and nothing else.

How is it that we can arrive at an implied volatility value without using an options pricing model like Black-Scholes? And how can it be that the VIX and the S&P 500 price levels are not directly related?

VIX and Variance Swaps

When institutional investors want to trade volatility, they often trade variance swaps. The magic of a variance swap is that by using a portfolio of options weighted in a certain way, the impact of other factors, such as the changing underlying index level, can be neutralized. The trader is left with exposure to volatility alone.

VIX uses the same processes employed in variance swaps to arrive at the same result: exposure to pure volatility. Though the math behind variance swaps is complicated, one simple technique, explained below, liberates VIX from the influence of other factors.

How Volatility is Isolated

A challenge in calculating a volatility index is that, as a general rule, options have higher sensitivities to changes in implied volatility (“vega values”) as their strike prices increase, as shown in Figure 1. The bell curves in this graphic represent the sensitivities of options to implied volatility at different strike prices.

Figure 1

Vega increasing

This upward sloping effect links the price of the underlying index with the volatility exposure of the full portfolio. If the underlying index price is high, then the sensitivity of the options to changes in implied volatility will be high as well.

To offset this effect, the options need to be reweighted. The result of this reweighting is illustrated in Figure 2. The options demonstrate the same relative sensitivity to implied volatility in the portfolio regardless of the underlying index price.

Figure 2

Vega even

 

This is achieved through weighting the options by the inverse of their strike prices, squared. So, options with lower strike prices are given a higher weight to make up for the fact that they naturally have less sensitivity to changes in implied volatility.

This is the essence of the VIX calculation: a reweighting of the options so that exposure to implied volatility rises and falls independently of the underlying index price level. This is what allows VIX to be VIX, a pure measure of volatility, uncontaminated by other effects and factors.

For a deeper dive into this concept – and better charts! – I recommend reading a renowned paper published by Goldman Sachs in 1999. The ideas in this piece served as the foundation for the modernization of the VIX methodology, which took place in 2003.

 

 

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

SPIVA® Europe Scorecard 2014: How did active funds perform versus their benchmarks?

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Daniel Ung

Director

Global Research & Design

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Published every six months, the SPIVA Europe Scorecard aims to measure the performance of active funds against their corresponding benchmarks.  The results for the Year-End 2014 Scorecard are now in, and they reveal few surprises.

Euro-Denominated Funds
In spite of a slight improvement in the last quarter of the year, growth in Europe for the other quarters of 2014 was generally anemic.  At the start of the year, the markets had generally been optimistic that the European Central Bank (ECB) would start quantitative easing in the event of continued slow growth, but they were disappointed that the ECB did not announce any concrete measures.  This led to bouts of high volatility throughout the year and a generally lackluster performance in the equity markets.  Normally, these conditions would be ideal for active managers, but our report indicates that the majority of euro-denominated funds invested in European equities trailed their respective benchmarks over the one-, three-, and five-year periods.

This pattern of underperformance[1] was not only limited to European equities. We saw a similar pattern of underperformance in euro-denominated funds invested in other regions, such as emerging markets, the U.S., and international markets (see Report 1).

Sterling-Denominated Funds
In regards to sterling-denominated fund categories, some categories of active funds invested in U.K. equities performed well.  Across all time periods, the majority of U.K. large- and mid-cap funds posted higher returns than their benchmark, suggesting that active management opportunities may be present in the U.K. large- and mid-cap spaces.

However, sterling-denominated funds invested in emerging markets, the U.S., and international equities underperformed their corresponding benchmarks.  This is in line with the finding for euro-denominated funds invested in these markets.

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[1] In order to be consistent with SPIVA reports in other regions, funds that have disappeared during the relevant reporting period are now considered to be underperforming the benchmark in the computation of the results in Report 1.

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