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As goes the first week, so goes …

Asian Fixed Income: 2015 Pan Asia Report Card

China’s Stock Market and Its Currency

Not Your Father’s Low Volatility Strategy

New Year’s Resolution: Lose Weight...in Carbon

As goes the first week, so goes …

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Tim Edwards

Managing Director, Index Investment Strategy

S&P Dow Jones Indices

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The world’s equity markets have encountered a rocky introduction to 2016; including the worst ever start for the Dow Jones Industrial Average (against a record that stretches back to 1897) and steep falls across developed and emerging markets.  Equity markets are down more or less everywhere, and in many cases materially so.

What difference does a week make?

Does the performance in the first seven days of the year matter to investors who intend to hold through to year-end?  One would suppose not especially: there are 51 weeks to go, we have covered less than 2% of the year and – in the abstract –the first week’s performance should have only a tiny (although certainly non-zero) influence on the whole year’s return.  Yet, history suggests the opposite.  Some weeks were more important than others, and the performance in first week of the year was particularly indicative of the year’s returns.

How important is the first week?

Taking the international blue-chip S&P Global 1200 and its performance over the past 25 years as our object of study (similar results may be obtained with the S&P 500), it is clear that there is a strong historical relationship between the performance during the first week of the year and the overall year’s return, with a positive correlation of 0.41.  Pic1Not all weeks are equally important

Some weeks seem to be more important than others, or even provide an entirely opposite relationship to that expected; the third week in May, for example, seems to be negatively related to performance throughout the remainder of the year. (Support, perhaps, for notion that one should “sell in May and go away”.)Pic2

Which is the most important week?

Perhaps thanks to the return of investors from their holidays and the frequent location of elections during the period, the first week of September appears to be the most influential week for returns.  This is followed by the second weeks of November and March, then the second week of September.  The first week of the year appears in fifth place – still pretty influential, but far from the most important.Pic3

Conclusions

Historically speaking, years that have started badly have more frequently ended badly – and to a greater extent than might be supposed, given the expected impact of a single week’s performance.  However, those who wish to divine the market’s yearly performance from that of a single week might be better off waiting until September.

 

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

Asian Fixed Income: 2015 Pan Asia Report Card

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Michele Leung

Director, Fixed Income Indices

S&P Dow Jones Indices

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Despite the weakness in local currencies, the S&P Pan Asia Bond Index, which is designed to track local currency bonds in 10 countries and is calculated in USD, delivered a total return of 1.45% for 2015.  The S&P Pan Asia Corporate Bond Index rose 2.54% in the same period, outperforming the S&P Pan Asia Government Bond Index.

Among the 10 countries tracked by the S&P Pan Asia Bond Index, India was the best-performing country for the year; the S&P BSE India Bond Index rose 8.40% in 2015, while its yield-to-maturity closed at 7.89%.  The S&P China Bond Index went up 8.05%, despite the equity market volatility and slowdown in China.  Though these returns were shy of their double-digit gains of 2014, the gains were robust given the challenging market conditions.  Indonesia had a volatile year, the S&P Indonesia Bond Index managed to reverse its earlier loss in Q3 2015 and ended the year with a 4.35% total return; its yield-to-maturity reached 8.88% and it was the highest-yielding country in the region.

The size of Asia’s local currency bond markets, as measured by the S&P Pan Asia Bond Index increased 21% to USD 8.40 trillion in 2015, which reflected the continuous market expansion.  The market value tracked by the S&P China Bond Index expanded 40% to RMB 36.9 trillion, fueled by the municipal bond replacement program and the growth in the corporate market.

Exhibit 1: Total Return of the S&P Pan Asia Bond Index Series in 2015

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Source: S&P Dow Jones Indices LLC.  Data as of Dec. 31, 2015.  Chart is provided for illustrative purposes only.

Exhibit 2: Yield-to-Maturity of the S&P Pan Asia Bond Index Series

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Source: S&P Dow Jones Indices LLC.  Data as of Dec. 31, 2015.  Chart is provided for illustrative purposes only.

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

China’s Stock Market and Its Currency

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David Blitzer

Managing Director and Chairman of the Index Committee

S&P Dow Jones Indices

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The New Year opened with large declines and massive volatility in China’s stock market.  According to US press reports, continuing declines in the value of China’s currency, the RMB, are a major factor in the poor performance of the market. While the RMB has slid against the dollar, falling from 6.21/USD at the beginning of 2015 to 6.59/USD on January 7,  2016, a loss of 5.8%, it appreciated when measured against the Australian dollar, the euro and the British pound.  China’s currency may be weakening, but that is only part of the FX story – the rest is the strengthening of the US dollar.

The table shows how the RMB has moved against the dollar, yen, pound, euro and Australian dollar. Since the beginning of last year the RMB fell vs. the dollar and the yen, was roughly flat against the pound and rose against the euro and the Australian dollar.  Estimates of trade between China and other countries, reported by the People’s Bank of China in constructing a trade-weighted index of the RMB, show that US traded was 26.4% of the total, euro-denominated trade 21.4%, yen-denominated 14.7%, 6.6% in Hong Kong Dollars and the rest spread across eight other currencies. These figures confirm what the table above shows: the RMB is not universally weaker. Rather, its weakness shows up in about half its trade covering the US, Japan and Hong Kong.  With other currencies in other markets, the RMB is stable or appreciating.  While exchange rate shifts of 5% to 10% in a year are large, the RMB’s movement cannot explain most of the difficulties facing the Chinese stock market.

The chart shows the exchange rates measured as indices (RMB per foreign currency) where all indices are based at December 8, 2014 =100.  Since higher numbers mean a weaker RMB, the vertical axis is inverted. The Chinese devaluation of August 10-11, 2015 is clear on the chart.   The sharp declines in the red and blue lines at the lower right are the weakness against the US dollar and the yen.

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

Not Your Father’s Low Volatility Strategy

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Fei Mei Chan

Director, Index Investment Strategy

S&P Dow Jones Indices

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Low volatility strategies were a popular and growing category in 2015, and if the first several days of 2016 are any indication, it wouldn’t be surprising to see their popularity continue in the new year. That said, the topic of low volatility investing often comes with much discourse. A frequent argument is that a low volatility tilt is very similar, if not synonymous, to a bet on a small number of sectors or industries. In its 25-year history, the S&P 500 Low Volatility Index has often had high concentration in low volatile sectors – most frequently Utilities, Financials, and Consumer Staples. The index seeks out the least volatile stocks—with no sector constraints—so having large positions in sectors with relatively lower risk is not surprising.

not your father's low volatility strategy

However, there’s more to the low volatility story than a sector bet . As an exercise, we produce a hypothetical low volatility portfolio whose sector weights match those of the S&P 500 Low Volatility Index but whose sector returns match those of the complete S&P 500. The hypothetical results tell us to what extent Low Vol’s results come from sector tilts alone, vs. stock selection within sectors.

As shown below, over the last 25 years the hypothetical portfolio’s standard deviation was between those of the S&P 500 and the S&P 500 Low Volatility Index. Being in the Low Vol’s sectors during this period accounted for more than two-thirds of the total volatility reduction achieved by the S&P 500 Low Volatility Index. In the same period, the return increment attributed to being in the “correct” sector was only 24%. More than three-quarters of Low Vol’s outperformance is idiosyncratic to its stock selection methodology.

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We’re not alone in arguing for the existence of the low volatility effect independent of sector impacts. Baker, Bradley, and Taliaferro, in decomposing the low risk anomaly, found that stock selection contributed to higher alpha, while the contribution from industry selection was negligible. Asness, Frazzini and Pedersen concluded that even holding the industry effect neutral, low volatility bets exhibited positive returns.

The implication of all this research is that a sector tilt can’t account for all the performance differentials of low volatility. To assume that the two strategies are synonymous is to leave something on the table.

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

New Year’s Resolution: Lose Weight...in Carbon

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Neil McIndoe

Head of Environmental Finance

Trucost

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Global emissions of carbon dioxide (CO2) would have to fall by about 60% by 2050 to limit the increase in average temperature to 2°C above pre-industrial levels. Over the last 40 years, CO2 emissions have mostly risen or remained flat, and fallen only following major economic crises. Add to this a global population that is projected to grow to 9.6bn by 2050 and that 2°C target looks increasingly unrealistic. The International Energy Agency has stated that the world is on course for average temperature rises of at least 4°C, not the 2°C targeted by policy makers. Correcting this gap will almost certainly involve a much tougher regulatory framework with a higher cost of carbon at its core.

The current response to such carbon cost risks from the fund management industry is extremely varied and therefore continues to be a concern for institutional investors including pension funds. Without accurate measurement of these risks, investors may struggle to manage the risk effectively.

Step onto the scales

A carbon footprint analysis quantifies the greenhouse gas emissions (GHG) emitted by companies in the portfolio. The analysis also takes account of purchased electricity, business travel, and logistics. The carbon footprints of portfolios, expressed in tonnes of carbon dioxide equivalent (CO2e) provide a comparable measure of emissions associated with holdings and provide a useful indicator for related exposure to carbon costs.

The carbon footprints of funds can vary dramatically. In one case we analysed two funds with the same investment style where the smaller footprint was 209 tonnes of CO2e per £ million invested and the larger footprint was 1,487 tonnes CO2e/£ million—that’s seven times more exposure to potential carbon costs. Neither fund manager considered CO2 in their investment process.

Other useful metrics include an analysis of a portfolio’s exposure to stranded fossil fuel assets. If only one-third of already discovered fossil fuel deposits can be burned if we are to keep to a 2 degree limit, why are many oil & gas companies allocating large capex to discovering more?

A measure can also be given for the alignment of a portfolio’s energy investments with pathways that would support a low-carbon economy. This is useful because any regulation and subsidies that come forward to support such a transition could have cost implications for the heavier carbon fuel producers.

Climate change risk is therefore an issue that pension funds trustees may increasingly look to assess and actively manage. Carbon exposure, in particular, may be a clear risk to portfolio returns that can be quantified.

Low-carbon indices – healthier benchmarks?
In response to demand for benchmarks that take into account carbon exposure risk, S&P DJI has introduced low-carbon versions of many of its well-known indices. For instance, the S&P Carbon Efficient family includes the S&P 500® Carbon Efficient Index, which closely tracks the performance of the S&P 500 while significantly reducing the carbon footprint of the overall portfolio. It has a six-year track record of delivering returns that are similar to those of the S&P 500, but with around 50% less exposure to potential carbon emission risks.

Working out a carbon fitness regime
To achieve low carbon exposure, investors may wish to:

  • Track how a fund’s carbon exposure compares to that of the benchmarks.
  • Monitor portfolios on greenhouse gas emissions and related exposure to carbon costs under existing and planned regulatory frameworks.
  • Develop processes to proactively manage emissions-related risks and opportunities in portfolios to better protect savings.

Wishing you a healthy and prosperous new year.

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