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Losing My Religion: Value in the USA

The Rieger Report: Puerto Rico - a 22% Weight on the High Yield Muni Market

DJSI: A Journey Toward Sustainability and Beyond

The Fed and the Debt Ceiling

The Effects of Regulation on Prescription Drugs

Losing My Religion: Value in the USA

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Tim Edwards

Managing Director, Index Investment Strategy

S&P Dow Jones Indices

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If simple is beautiful, then value investing is the equity market’s Helen of Troy – the faith that launched a thousand funds.  If a company’s assets or profits are high in relation to its share price, it does not require much imagination to suppose that such company might offer attractive long-term investment prospects.

Value is also a “smart beta,” having been indicized – the concept of overweighting companies whose stock price is relatively cheap compared to their fundamentals underlies a swathe of indices, many of which have gained a broad traction with investors.

Value – the theory goes – works most of the time in the long term, and some of the time in the short term.  As far as the U.S. markets are concerned, at the very least, an increasing degree of patience may be required.

But is “value” still working?

This is both an easy and a difficult question to answer.  First, the easy answer.  S&P Dow Jones Indices encodes value in several different U.S. based indices, reflecting the priorities of various different value investing schemes.  We can examine the performance of these various value strategies, in comparison to an appropriate benchmark, over the long and short term.  Such performance comparisons can also test the support for the various theses – such as the hope that value investments will weather crises more steadily – that are used in support of value investing as a style.  The charts below show the relative performance of four value indices based on U.S. equities, over the past year and decade.

YTD

Note on reading the chart: if value is above 100%, the relevant index has outperformed its benchmark by a proportion equal to the chart level since the start date – if below, it has underperformed by that proportion.  And note that the benchmarks for relative performance vary among value indices; as we’ve indicated previously in our research on value indices, an equal weight benchmark is a better indication of the value-added by the particular index methodology.

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The result of such comparisons is conclusive: in both the short-term and long-term, value indices have been underperforming.

Of course, the harder question is whether value will “work” in the future.  Value investing is typically supported, at the last, with the historical fact that – in the long, long term – value investing has outperformed.  But there is always a disclaimer that the future may not reflect the past, and there is something different this time.

So, What’s New?

This difference is hinted already by the existence of our value indices: as a concept, value has become remarkably popular in recent times.  A vast bank of academic literature has been published on the subject; systematic strategies have been encoded and funded to capture it.  To give a sense of this growing popularity, the next chart shows the assets outstanding in U.S. listed ETFs that have the word “value” somewhere in their name; the growth in assets outpaces the investment growth (as proxied by the S&P 500 Value Index) by a close to a ten times multiple.

Growth in Assets in “Value” ETFs, Dec 2007 – Oct 2015

ETF AUM

With so much energy directed to exploiting the excess returns available through value investing, maybe the only “value” stocks left are the value traps, those stocks whose prices are low as their prospects are determinedly poor.  And, if the popularity of value strategies increases sufficiently to diminish future returns, investors may be better served focusing on other factors.

Like the topless towers of Ilium, investors can be burned by relying on the wrong factors.   It remains to be seen whether the returns over previous decades attributed to a “value” premium are due a comeback.  More broadly, the persistence of excess returns attributable to the kind of simple strategies that can be indicized – like value – are not guaranteed; careful analysis of persistence is a matter of great importance.

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

The Rieger Report: Puerto Rico - a 22% Weight on the High Yield Muni Market

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J.R. Rieger

Head of Fixed Income Indices

S&P Dow Jones Indices

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As the Puerto Rico saga continues it has created a drag on the high yield municipal bond market.

The weight of Puerto Rico debt in the market place as measured the market value of bonds in select indices as of September 29, 2015:

The impact of Puerto Rico on year-to-date returns through that period is:

  • S&P Municipal Bond High Yield Index (Excluding Puerto Rico bonds): 4.42%
  • S&P Municipal Bond High Yield Index (Including Puerto Rico bonds):  0.89%

The expectations of defaults, creditor negotiations, and the uncertainty of legislation changes all make the situation fluid for the bond holders.

Learn more!  Join us on-line Wednesday October 28th as we live stream the complimentary 4th Annual Municipal and Global Bond Forum.  Click here for the agenda.

 

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

DJSI: A Journey Toward Sustainability and Beyond

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Manjit Jus

Head of ESG Ratings

RobecoSAM

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Last year the Dow Jones Sustainability Indices (DJSI) celebrated their 15 year anniversary, making them the longest running family of global sustainability indices in the world. The DJSI have been recognized as one of the most credible ratings in the world (GlobeScan / SustainAbility Survey) and have played a supporting role in leveraging sustainability as a key business driver for corporate success. The indices continue to serve as a key companion and benchmark for global companies across all industries throughout their sustainability evolution. The best-in-class approach allows companies to measure themselves directly against their peers and allows for healthy competition within an industry.  After all, no one likes coming in second place.

The DJSI rely on the information provided by companies via RobecoSAM’s Corporate Sustainability Assessment (CSA). The CSA is a unique collection of questions and criteria, addressing the most material sustainability issues within each of the 59 industries that are assessed. The wide range of topics go beyond the traditional environmental, social, and governance approach, aiming to find the intersection between what matters most to companies and investors. Topics like innovation management, customer relationship management, and tax strategy are perhaps not topics that would normally be connected to the word “sustainability,” but for RobecoSAM, these are key areas that drive long-term value creation within companies.

The information submitted by companies needs to be backed by supporting documents (audit reports or publicly available information), and the CSA process itself is audited by Deloitte. Additionally, a Media and Stakeholder Analysis (MSA) is used to monitor companies continually, ensuring that they are upholding their sustainability commitments and adhering to the principles and policies they communicate to their stakeholders.

The recent Volkswagen scandal highlights the rigorous procedures in place to ensure that the integrity of the DJSI remains intact. Potential problematic issues relating to any DJSI component company automatically trigger an MSA. Following the MSA, the Dow Jones Sustainability Index Committee (DJSIC) reviews the issue and decides whether the company will remain in the index, based on DJSI Guidelines. In Volkswagen’s case, the result was exclusion from the DJSI. DJSIC decisions are reviewed annually, and RobecoSAM maintains communication channels with the companies in question on behalf of the DJSIC to track their progress.

Like the 15-plus-year development of the DJSI, the CSA has been subject to change over the course of its 20-year life, aiming to address the emerging risks and opportunities within industries on an ongoing basis. Corporate sustainability has come a long way, and investors see sustainability not only as a means of mitigating or avoiding risks, but also for seizing new opportunities that arise. Similarly, the CSA has evolved to identify the companies that are leveraging these opportunities as new sources of value creation, while challenging them to rethink the way they communicate about sustainability.

In 2015, 864 of the world’s largest organizations participated in the CSA, investing a sizeable amount of time, effort, and manpower to ensure that the results best reflected their sustainability efforts. Beyond vying for a place in the DJSI, companies are compensated for their efforts through the feedback received from the DJSI, which is often used as a way to measure the investment community’s views on emerging sustainability issues. For instance, in 2014, the tax strategy criterion was introduced, which was initially received with mixed reactions, as companies felt this was out of context and were unable to provide answers to the questions asked. One year later, almost twice as many companies answered these questions, highlighting that the topic of tax transparency has made it onto their sustainability agenda and is being addressed by other stakeholders. RobecoSAM encourages companies to participate actively in the CSA—we see it as a playbook for embracing and adopting financially material topics, challenging them with new long-term risks and opportunities, and ultimately for finding innovative sources of competitive advantage.

Now in their 16th edition, the DJSI continue to serve as the leading global benchmark for corporate sustainability, and the collaboration between S&P Dow Jones Indices and RobecoSAM continues to provide the basis for new, cutting-edge sustainability products for investors. The CSA remains the foundation of this product development and helps corporations and investors achieve long-term value from sustainability, regardless of how far they’ve come on their own sustainability journeys.

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

The Fed and the Debt Ceiling

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David Blitzer

Managing Director and Chairman of the Index Committee

S&P Dow Jones Indices

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Two distractions creating uncertainty for the treasury market right now are the debt ceiling and who said what at the Fed. Both annoyances should fade away, one in a few weeks, the other possibly not until sometime in the first half of 2016.

The debt ceiling law dates back to shortly before the Second World War.  It covers the total federal debt; the current limit is $18.1 trillion. The Treasury Secretary says that the debt will be hit the first week in November as all the extraordinary measures to conserve cash are exhausted. Most of the time there is enough room between the current total debt and the ceiling that ceiling doesn’t matter much. However, every so often the amount of debt approaches the ceiling and Congress must pass a bill to increase the ceiling. Practically speaking lowering the debt isn’t an option. However, surpluses during the Clinton administration did somewhat reduce the debt and leave more room below the ceiling.

Since Congress must approve all tax and spending bills, it is not clear why the debt ceiling is necessary. However, the periodic debt ceiling battles give Members of Congress an excellent opportunity to complain to the government about the government – so permanently eliminating the debt ceiling isn’t too likely.

What to spend or tax is economics, the debt ceiling is politics. There will be a lot of political grandstanding and noise.  But everyone knows that defaulting rather than raising the debt ceiling would be disastrous. The debt ceiling will be raised in the end and then everyone will claim to have saved the day at the last moment. However, in the run-up to “victory” we could see yields on treasury securities scheduled to mature between now and November 15th jump higher or crash.  The chart below, from a recent report by the Congressional Research Services (see www.crs.gov #R43389) shows T-bill yields during some previous debt ceiling debates.

The FOMC, the Fed’s policy unit, meets next week on Tuesday and Wednesday. There is little chance that they will raise interest rates at the meeting. First, raising interest rates just as the debt ceiling is roiling the market isn’t a good idea. Second, there isn’t much new economic data since the last meeting on September 16th-17th and there is no post-meeting press conference scheduled.  Despite these reasons, right now there is an unusual amount of debate and discussion about Fed policy.

The FOMC is data-driven, its decision on raising interest rates, whenever it happens, will depend on how the economy looks at that time. The question of what they might do in at the December 15th-16th meeting depends on the economic reports appearing between now and then.  Moreover, as the economic numbers change, so do people’s opinions of the future. There is a lot of uncertainty and noise in forecasts of the Fed’s next move.  Currently the noise level is increased because of apparent disagreements among members of the Fed Board of Governors. In the last few weeks, Stanley Fischer argued for raising rates sooner while Lael Brainard and Daniel Tarullo spoke in favor of waiting longer and everyone is trying to guess Janet Yellin position.

Will the Fed act in December? If we knew what the future data will reveal and how people would react, we might have an answer.  What is likely is that until then the markets will see extra uncertainty even though the debt ceiling will have been raised.

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

The Effects of Regulation on Prescription Drugs

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Glenn Doody

Vice President, Product Management, Technology Innovation and Specialty Products

S&P Dow Jones Indices

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According to a story in Canada’s Globe and Mail, one drug maker is about to take on an entire country to protect its right to price drugs the way they see fit.  Alexion Pharmaceuticals, the maker of the drug Soliris, has announced a lawsuit against Canada’s Patented Medicine Prices Review Board after the board began hearings in June to pressure Connecticut-based manufacturer Alexion Pharmaceuticals to lower the drug’s “excessive” price.  The Globe and Mail reports that, “the drug—dubbed the world’s costliest treatment for two rare, life-threatening blood and genetic disorders—is reportedly priced at between USD 500,000 and USD 700,000 annually per patient.”

According to the article, only two countries in the Organization for Economic Cooperation and Development have open pricing on drugs, the U.S. and Chile.  Canada’s regulation of overpricing of patented drugs dates back to 1987, with the establishment of the Patented Medicines Prices Review Board, a regulatory oversight body that has been granted the right to review and control prices of drugs still under patent, and it is a negotiated feature of the North American Free Trade Agreement established in 1994.  Prior to the free trade agreement, drug companies had much less protection against patent infringement by generic drug manufacturers long before their U.S. patents expired.

How effective has this board been at controlling overall drug prices in Canada?  By comparing the unit cost of brand drugs sold in Canada since 2009 to those sold in the U.S. (as measured by the S&P Healthcare Claims National Index), we can determine that on average, brand name drug prices have escalated 132% in the U.S. versus 23% in Canada.  Even if we remove 2014, when specialty drugs accounted for an increase of almost 30%, the six-year increase is still 119% in the U.S. versus just 18% in Canada.  Exhibit 1 illustrates the difference in cost increases in unit costs for both countries.

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When comparing these cost increases to the average change in generic drug costs over the same period, we can see that open and competitive markets have led to a cost escalation of 8% in the U.S. and a 19% decrease in average costs of in Canada.  Taking these results into account, it becomes apparent just how important this lawsuit is for Canada, however U.S. lawmakers may want to take notice as well.  With a well-documented example from our neighbors to the north, a regulated market may be one potential solution for cost control for brand name drugs in the U.S. market.

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