Investment Themes

Sign up to receive Indexology® Blog email updates

In This List

Rising Dispersion and the Value of Stock Picking

Concentration Consternation

A Game of Thrones Using ETFs

U.S. Bond Prices Have Moved Up as Chinese Stock Prices Have Plunged

Commodities Hit Lowest in More Than 13 Years

Rising Dispersion and the Value of Stock Picking

Contributor Image
Craig Lazzara

Managing Director and Global Head of Index Investment Strategy

S&P Dow Jones Indices

two

The U.S. equity market’s dispersion rose substantially in July, ending the month at 7.3%, well above June 30’s 4.5%.  Dispersion for the S&P MidCap 400® and S&P SmallCap 600® likewise rose in July, and the component correlation of all three indices declined.  This is not surprising in a month dominated by individual earnings announcements.  Lower correlation means there’s less tendency for stocks to move together, and higher dispersion means that the gap between the winners and the losers grows — more or less what we’d expect when company, rather than macroeconomic, news is most important.

We’ve long argued that the market’s low dispersion in 2014 was a major contributor to the failure of most active managers to outperform their index benchmarks.  So if dispersion remains high, other things equal, active stock pickers might benefit.  But there are at least three cautions to offer before concluding that the long-sought “stock-picker’s market” has finally arrived.

First, dispersion might not stay high.  July’s upward move is impressive, to be sure, but in January 2015, S&P 500® dispersion rose from 4.2% to 6.7%, a move almost as large as July’s.  Dispersion fell in the next two months, so that by the end of March, it was back to its year-end level.  One month, in other words, does not a high dispersion regime make.

Second, the percentage of active managers who outperform their benchmarks does not depend on the level of dispersion.  Dispersion is a pre-cost measure, so if dispersion rises relative to its 2014 level, more managers may be able to earn enough incremental return to cover their trading and research costs and generate positive alpha for their clients.  But this is a marginal effect.  As our SPIVA research has consistently demonstrated, most active managers underperform most of the time.  If dispersion rises, successful stock pickers will earn more, and unsuccessful stock pickers will lose more.

Finally, rising dispersion will have predictable effects on the performance of some factor indices.  For example, if winners keep winning and losers keep losing, that’s a recipe for increased dispersion.  In such an environment, momentum indices (which buy winners and shun losers) will tend to do well, and equal weight indices (which do the opposite) will tend to underperform.  (In July, in fact, the S&P 500 Momentum Index outperformed its equal weight counterpart.)  Through July 31, the cap-weighted S&P 500 outperformed equal weight (3.35% vs. 1.69%).  Rising dispersion might cause that gap to widen.

An equal weight index measures the return of the average index component.  When equal weight is outperforming cap weight (as it typically does), stock picking is relatively easy — in fact a randomly-chosen portfolio should outperform the cap-weighted index.  When cap weight outperforms, stock picking is much harder.  (Some active managers recoil in horror at the memory of the late 1990s, when the cap-weighted S&P 500 outperformed equal weight for six consecutive years.)  If cap weight continues to outperform equal weight, stock selection will continue to be challenged, regardless of dispersion’s level.

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

Concentration Consternation

Contributor Image
Chris Bennett

Director, Index Investment Strategy

S&P Dow Jones Indices

two

“There are 3 kinds of lies: lies, damned lies, and statistics.”- Mark Twain

Earlier this week, The Wall Street Journal pointed out that a mere six stocks (Amazon, Google, Apple, Facebook, Gilead, and Disney) had accounted for more than 100% of the S&P 500’s year-to-date gains.  This degree of concentration (reminding some of the peak of the 1990s’ technology bubble) is said to raise “concerns about the health of the market’s advance.”  While the article’s arithmetic was correct, its concerns may be misplaced.

We don’t have to look back to the tech bubble to see a similar concentration of index returns: During 2011, 4 stocks (Exxon, Apple, IBM, and Pfizer) accounted for more than 100% of the total return of the S&P 500. This did not “presage a pullback,” however, as the S&P 500 followed with 3 straight years of double-digit gains.  What was similar about 2011 and 2015 through July 27 (the date of the Journal’s analysis)?  Aggregate returns were de minimis.  In 2011, the S&P 500 gained 2% on a total return basis (and was flat on a price return basis). The total return of the S&P 500 in 2015 was less than 2% through July 27.  In both periods, the return of the index was relatively low, making it easy for a small group of strong stocks to account for more than 100% of total performance.

Following a few positive trading days, incidentally, “The Only Six Stocks That Matter” now account for only half of the S&P 500’s year to date total return.  As of July 29, it would take 22 stocks to account for 100% of the market’s return.

Just as the concentration of performance doesn’t lead to reliable conclusions about the market’s future absolute return, it also tells us little about the relative performance of active managers vs. their passive benchmarks.  Active managers tend to underperform both when index returns are heavily concentrated among a few stocks and when returns are more widely distributed.  In 2011, when four stocks accounted for 100% of the market’s return, 81% of large cap U.S. funds lagged the S&P 500.  2014 was quite a different year in terms of returns and individual stock contributions to index returns: the S&P 500 ended the year up 14% and it required 176 stocks to account for the market’s total return.  Yet active managers did not prosper in these conditions either, as 86% of large cap funds failed to outperform the S&P 500.

While it makes for an exciting headline, concentration is no cause for consternation.

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

A Game of Thrones Using ETFs

Contributor Image
Michael Mell

Senior Director, Custom Indices

S&P Dow Jones Indices

two

As hedge funds arguably best embody the spirit of active management you know it’s a watershed moment when “exchange-traded funds, which are the primary vehicle for passive management, now have assets under management greater than hedge funds, according to a count from research firm ETFGI.”  Industry-wide, it has been observed that “growth in ETF assets continues to outpace assets under management (AuM) expansion in the wider asset management industry.”  So while the active versus passive debate is often positioned as on-going, one could argue that it’s over (or ending very soon).  Passive has won (or is winning).  The game of thrones is over; house passive sits triumphant on the iron throne.

Thus one would think that we have arrived at a moment where believers in passive investing should celebrate.  Not unlike the legions of undead preparing to attack the wall a rude awakening is upon us.  A bifurcation is occurring in the ETF industry, and it has a direct impact on the passive versus active debate, because to date, ETFs have been the primary vehicle for executing a passive strategy.  “In early November 2014, the SEC approved another version of non-transparent active investment product called exchange-traded managed funds (ETMFs). The SEC approval of ETMFs and potentially other requests for non-transparent active ETFs could lead to another phase of growth and innovation for ETFs in the U.S.”  So while the index based ETF industry has been growing and fueling victory for the passive vs. active debate “traditional fund providers are taking action, creating ETF teams of their own as a precursor for potential future launches.” In other words, in the future hordes of active mutual fund companies may raise their dying products from the dead in the body of “ETFs”.

With active ETFs, ETMFs, and “ETFs” tracking indices by providers you’ve never heard of and “ETFs” with indices calculated by smaller players who may or may not be here tomorrow, it’s getting scary out there for anyone seeking to gain some type of reliable beta exposure.  On the other hand, “the vast majority (approximately 99%) of U.S. ETF assets are currently in passively managed index products. Active ETFs accumulated approximately $16 billion assets under management (AUM) between 2008 and mid-2014.”  So breathe easy right?  No because winter is coming, change is upon us.  However as I referenced in an earlier blog, there is a way to know if your ETF is truly passive and it will be more important than ever to use that formulaic approach to see what’s actually under the hood of an “ETF”.

 

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

U.S. Bond Prices Have Moved Up as Chinese Stock Prices Have Plunged

Contributor Image
Kevin Horan

Director, Fixed Income Indices

S&P Dow Jones Indices

two

This week (starting July 27, 2015), the bond market has been off to a strong start, with the yield of the U.S. 10-year Treasury bond at 2.22%.  U.S. bond prices have moved up as Chinese stock prices have plunged.  Last week saw Treasury yields move lower, as dropping commodity prices followed the weaker CPI numbers that were released on July 17, 2015.  Since June 30, 2015, the price of crude oil futures has dropped from 59.83 to its current level of 47.49.  The yield-to-worst of the S&P/BGCantor Current 10 Year U.S. Treasury Index has moved lower by 9 bps throughout this week.  As of July 27, 2015, the index has returned 1%, after starting off in the red.  The index has returned 0.71% YTD, inching closer to the 1% return it had at the beginning of the month, but it was nowhere near January 2015’s 5.26% YTD return.

The S&P 500® Bond Index has seen its performance improve over the last week, as the month-to-date return, which had been negative since July 10, 2015, was able to recover and pushed out of negative territory on July 22, 2015, to reach 0.312%.  The index was still negative YTD, at -0.323%, but it is not as low as the -1.125% that was posted on July 13, 2015.  The broader, investment-grade index (S&P U.S. Investment Grade Corporate Bond Index) has returned 0.28% MTD and -0.18% YTD as of July 27, 2015.

High-yield bonds, as measured by the S&P U.S. Issued High Yield Corporate Bond Index, have seen their yield-to-worst widen by 24 bps just in the four days before July 27, 2015.  The energy sector accounts for a 15% weight of the index and has underperformed by -5.94% MTD.  The overall index has returned -0.97% MTD and 1.52% YTD.

The performance of the S&P/LSTA U.S. Leveraged Loan 100 Index has followed that of the high-yield index, but at a more conservative pace.  The index has returned -0.18% MTD and 1.58% YTD.  The crossover at which loans started outperforming high yield on a YTD basis occurred just last week, on July 23, 2015.
Month to Date Index Value Comparison

 

 

Source: S&P Dow Jones Indices LLC.  Data as of July 24, 2015.  Leverage loan data as of July 26, 2015.  Past performance is no guarantee of future results.  Chart is provided for illustrative purposes.

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

Commodities Hit Lowest in More Than 13 Years

Contributor Image
Jodie Gunzberg

Managing Director, Head of U.S. Equities

S&P Dow Jones Indices

two

The S&P GSCI has lost 13.6% month-to-date through July 27, 2015, bringing its level to the lowest since February 25, 2002. It has now exceeded the bottom of the 2008 global financial crisis. Please see the chart below:

Source: S&P Dow Jones Indices.
Source: S&P Dow Jones Indices.

Thus far, July 2015 is the seventh worst performing month in the history of the S&P GSCI that goes back to January 1970. It is one of the worst months in more than 45 years or 547 months. Please see the table below for the six months that fared worse:

Source: S&P Dow Jones Indices.
Source: S&P Dow Jones Indices.

Every single one of the 24 commodities is negative for the month except lean hogs, which is just barely positive by 18 basis points BUT only when taking into account the positive roll yield; otherwise that is negative too, by 14.5%. Throughout the history of the index, 23 commodities have been negative together in a month only once in September 2008 and all 24 were negative together only once in the following month of October 2008.  The single performer in September 2008 was gold, clearly different from today.

If the index were to fall back to the bottom before 2002, that happened on December 21, 1998, it has another 32% to fall. As the Wall Street Journal points out in this article, global growth is a major concern.

 

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