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Why Choosing Between Managers Requires a Two-Dimensional View - Part 1

Smart Beta on the Rise in India

Worst Crude Oil Start In History: Or Best Rebalance?

Using Indexing Tools for Risk Management — Sophisticated Strategies from Basic Building Blocks

Sukuk Market in 2015: Year in Review

Why Choosing Between Managers Requires a Two-Dimensional View - Part 1

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Raewyn Williams

Director of Research & After-Tax Solutions

Parametric™ Australasia

For large superannuation funds and other investors with institutional-sized portfolios, a common practice is to spread the allocation to a particular asset class among a number of managers within a “multi-manager” structure.  This provides the benefits of diversification not only across asset classes, but also within key allocations like Australian and global equities.  The aim of good manager selection is to construct an optimal style blend, noting that no one style is likely to perform well in all market conditions.

Manager research and selection is a specialist skill that requires a comparison of alternative managers across an array of attributes, especially their performance “track record.”  It is well accepted that past performance is no predictor of future results, so other attributes to be considered typically include each manager’s credentials, experience, fees, structures offered, technology, research pedigree, operational support, and trading efficiency.  Large superannuation funds will typically engage an asset consulting firm to assist them with manager research and may also subscribe to surveys and publications that report and rank manager performance.

Because so much attention is paid to managers’ performance track records, the way that performance is measured and compared by funds and advisors is important.  Yet, there is a vital piece of the picture missing, a concept that is continually overlooked when assessing managers’ performance: taxes.  Superannuation funds, like most investors, are subject to taxes on investment performance, and what really matters is “what members and investors eat” in the form of after-tax returns.  In an ideal world, it would be reasonable to assume that manager performance is, as standard practice, measured and compared on an after-tax basis.  Unfortunately, this assumption is wrong.

Consider two hypothetical international equity managers holding the same stock from the perspective of a taxable superannuation fund client with realized capital losses (see Exhibit 1).


In this scenario, a pre-tax focus tells the client that manager A is superior to manager B.  When faced with a reason to change the investor portfolio, the client is (in the absence of other differences) more likely to withdraw money from manager B than manager A, or terminate the mandate altogether.  Yet, viewing each manager’s performance through an after-tax lens shows that manager B has been more successful at building wealth for the superannuation fund client.

In part 2 of this article, we move from the hypothetical to an actual 10-year performance history of 198 U.S. managers.  We depict the “one-dimensional” view by plotting the pre-tax performance of these managers along a y-axis where seemingly “superior” managers rise to the top.  We then create a “two-dimensional” view by plotting these managers’ performance on an after-tax basis along an x-axis to show how truly revealing a two-dimensional view of manager performance can be.

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

Smart Beta on the Rise in India

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Utkarsh Agrawal

Associate Director, Global Research & Design

S&P Dow Jones Indices

Globally, passive investment products have amassed significant assets. According to ETFGI, the global assets parked in ETFs and ETPs stood at USD 2.971 trillion at the end of Q2 2015, surpassing the level of global hedge fund assets. The introduction of smart beta ETFs and ETPs has made it possible to gain exposure to certain risk factors through a passive route based on indices. An inherent advantage of the use of indices to incorporate risk factors, apart from the lower cost and tax efficiency, is transparency. According to ETFGI, as of October 2015, globally, smart beta equity ETFs and ETPs had assets of USD 399 billion. The U.S. and Europe have been at the forefront of passive smart beta adoption, with the Asia-Pacific region swiftly catching up on the smart beta wave. Within the Asia-Pacific region, India currently has one smart beta product based on dividends.

A factor-based portfolio allocation strategy aims to offer diversification benefits, as individual factors have generally low correlation with each other. These factors aim to help explain the sources of portfolio returns. Asia Index Private Limited, a joint-venture between S&P Dow Jones Indices and BSE, recently launched a suite of factor indices for the Indian equity market, designed to individually capture the low-volatility, momentum, quality, and value factors. These four factors are grounded in academic literature and have empirically shown their own risk premia. Let us take a quick look at the performance of these factor indices. Exhibit 1 shows the cumulative relative performance of these indices with respect to the S&P BSE SENSEX. Each factor index noted its own cycle over the past 10 years ending Nov. 30, 2015. From Exhibit 2, we can note that over the same 10-year period, the S&P BSE Momentum Index and the S&P BSE Enhanced Value Index had the lowest correlation of monthly returns, while the S&P BSE Low Volatility Index and the S&P BSE Quality Index had the highest correlation of monthly returns.

Exhibit 1: Cumulative Relative Returns 

Smart Beta 1

Source: S&P Dow Jones Indices LLC. Data from Nov. 30, 2005, to Nov. 30, 2015. Past performance is no guarantee of future results. Chart is provided for illustrative purposes and reflects hypothetical historical performance. The S&P BSE Momentum Index, S&P BSE Enhanced Value Index, S&P BSE Low Volatility Index, and S&P BSE Quality Index were launched on Dec. 3, 2015.

Smart Beta 2

Source: S&P Dow Jones Indices LLC. Data from Nov. 30, 2005, to Nov. 30, 2015. Past performance is no guarantee of future results. Table is provided for illustrative purposes and reflects hypothetical historical performance. The S&P BSE Momentum Index, S&P BSE Enhanced Value Index, S&P BSE Low Volatility Index, and S&P BSE Quality Index were launched on Dec. 3, 2015. 

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

Worst Crude Oil Start In History: Or Best Rebalance?

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Jodie Gunzberg

Former Managing Director, Head of U.S. Equities

S&P Dow Jones Indices

In the first 5 days of 2016, the S&P GSCI Crude Oil Total Return lost 10.5%, making it the worst start for oil in history. This oil mess has spilled into other commodities, driving the 3rd worst overall commodity start in history since 1970, losing 5.5% in 5 days. It is the worst start in almost a decade when the S&P GSCI Total return lost 6.4% in the first 5 days of 2007, and that was the worst start since 1975, when the index began with a 7.4% loss.

Energy is now down 8.8% driven by double digit losses in crude oil (-10.5%) and unleaded gasoline (-11.3%). If it weren’t for the cold weather supporting natural gas (+5.8%,) the whole sector might be down double digits. It seems the middle east tensions may have driven the likelihood for a supply increase rather than disruption, but the focus has shifted to the dollar strength and Chinese demand weakness.

The slowing Chinese demand and currency weakness are problematic for all commodities, not just energy. Already in 2016, there are 17 losers of 24 commodities with 4 of 5 sectors down. All five constituents in the Industrial Metals (-4.0%) are getting hammered with the S&P GSCI Lead Total Return down 9.9%, although energy is still the worst of the sectors.

Many of today’s reports pointed out that oil hit a new 12-year low, but the pace at which the price is falling is alarming. Now the S&P GSCI Crude Oil (Spot) level is the lowest since Feb 2004 and the price would need to be cut in almost in half to lose another multi-year leg that would put oil down to the bottom seen in Nov 2001. That’s not bad news.

The concern is for futures investors that need to pay rolling costs.  The S&P GSCI Crude Oil Excess Return that includes rolling costs is down far past a 2004 low, reaching its lowest since Feb 1999, and is on the verge of another multi-year loss. If the S&P GSCI Excess Return loses just another 5.5%, it will shed another 5 years of gains. 

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

This is happening at the most important time in the year for the indices, precisely at the rebalance. Not only is the timing important but (WTI) Crude Oil is taking over Brent Crude as the biggest index constituent in 2016. Maybe there is a silver lining that index investors are rebalancing back to crude with a 10% discount from the start of 2016. It is the “best buy” the index has ever seen at its annual rebalance based on the worst start for crude ever.

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

Using Indexing Tools for Risk Management — Sophisticated Strategies from Basic Building Blocks

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Jerry Miccolis

Principal and Chief Investment Officer

Giralda Advisors

Advisors today share a problem new to the careers of all but the eldest of us. As I discussed in a recent webinar, at Giralda Advisors, we call it the Portfolio Problem — unique in the last 30 years and arguably the most significant issue facing financial planning professionals over the next several years, if not decades.

The Portfolio Problem arises from these facts:

  • Most investors need a sizeable allocation to equities in their portfolios
    • Equities are the primary driver to help them achieve their long-term financial goals and stay ahead of inflation
    • However, equities are volatile and subject to significant drawdowns
  • Non-equity asset classes, a key purpose of which is to buffer the risk of equities, have become problematic
    • Fixed income investments, in particular, are poised for historically poor returns for the next several years, as their 30-year bull run fueled by declining interest rates is coming to an end — this is what makes the Portfolio Problem unique in the last three decades
    • Attempts to enhance fixed income returns introduce their own problems — increased risk and increased correlation with equities — that compromise the mission of this asset class
  • Diversification itself does not always protect the portfolio from equity risk
    • Contagion among asset classes, which occurs in times of extreme market stress, is immune to diversification
    • Even in the best of environments, portfolio risk mitigation through diversification is not guaranteed

So, how does a financial advisor solve the Portfolio Problem? We believe the answer may lie in an approach we call risk-managed investing (RMI). RMI attempts to explicitly mitigate equity risk at its source — directly within the equity investment itself, via dampening volatility and/or limiting downside potential. Let us illustrate by example how this can be done.

The two primary risks facing equity investors include recurring bear markets and sudden, severe market crashes. An effective RMI strategy attempts to address both of these risks.

Our RMI approach seeks to tackle bear market risk through a momentum-based sector rotation strategy. After detailed modeling and rigorous testing with basic industry sector indexes, we developed a strategy that provides buy and sell signals with the goal of exiting early from sectors that lead market declines. We execute the strategy with highly liquid industry sector ETFs. An illustration of the sector activity within our Sector Dynamics RMI strategy is shown in the graph below.


We address market crash risk with an RMI strategy that incorporates a custom-designed suite of tail risk hedges. These hedges are delivered via swaps whose value is derived from proprietary volatility-based indexes. The idea is to capture and monetize the spikes in volatility that typically accompany sharp equity market declines and to do so very cost-effectively. Several of these indexes are based on signaled exposure to VIX, itself a very popular volatility-based index.

We benchmark our RMI strategies against relevant indexes. Three in particular developed by S&P/CBOE that are very well suited to RMI are:

  • PPUT — an index of the S&P 500 and a rolling put
  • CLL — an index of the S&P 500 and a rolling collar
  • VXTH — an index of the S&P 500 and a VIX-based tail risk hedge

Indexing has played an important role in our RMI efforts, from strategy development, to product construction, to benchmarking. By using accessible indexing tools, a properly implemented RMI strategy can provide a sophisticated, innovative approach to mitigating downside portfolio risk — thereby elegantly solving the Portfolio Problem.

This material is for informational purposes only. Nothing in this material is intended to constitute legal, tax, or investment advice. Investing involves risk including potential loss of principal.
The views and opinions of any contributor not an employee of S&P Dow Jones Indices are his/her own and do not necessarily represent the views or opinions of S&P Dow Jones Indices or any of its affiliates.  Information from third party contributors is presented as provided and has not been edited.  S&P Dow Jones Indices LLC and its affiliates make no representations or warranties of any kind, express or implied, regarding the completeness, accuracy, reliability, suitability or availability of such information, including any products and services described herein, for any purpose.

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

Sukuk Market in 2015: Year in Review

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Michele Leung

Former Director, Fixed Income Indices

S&P Dow Jones Indices

The sukuk market demonstrated resilience despite the decline in oil price and global uncertainty; the Dow Jones Sukuk Index, which tracks USD-denominated, investment-grade sukuk, rose 1.24% in 2015, while the Dow Jones Sukuk High Quality Investment Grade Total Return Index gained 1.00% in the same period.  Looking closer at index constituents, the underperformers were sukuk issued by Saudi Electric, which were weighted down by the lower oil price, and the sovereign sukuk issued by Bahrain and South Africa.

From the supply perspective, we saw sovereign issuers from Malaysia, Indonesia, and Hong Kong, along with a few issuances from banks and a few corporates from GCC and Malaysia in the past year.  There were a total of 15 new sukuk with a total par amount of USD 11.95 billion being added into the Dow Jones Sukuk index, and 48% of them were from the Middle East and North Africa (MENA).  Though the amount of sukuk issued in U.S. dollars tracked by the index dropped in 2015, it is still a respectable level given the challenging market conditions (see Exhibit 1).

In fact, the sukuk issuance from MENA showed a diminishing trend in 2015, according to the Dow Jones Sukuk Index; Bahrain and Saudi Arabia had no issuance, while Qatar only managed to launch one sukuk of USD 750 million.  The United Arab Emirates is the only country in the Dow Jones Sukuk High Quality Investment Grade Total Return Index GCC that maintains stable issuances, and it is also the biggest USD sukuk issuing country, representing 24% of the overall index exposure.

From the demand side, the sukuk was well received overall.  In particular, the Malaysia Sovereign sukuk received strong support from investors across Asia, the U.S., and Europe. While the issuance in Q3 2015 was muted, the sukuk launched in Q4 2015 received a solid order book of two-to-three times oversubscribed.

Among the ratings-based subindices, the bucket rated ‘BBB’ outperformed and rose 2.14% in 2015. Interestingly, the bucket rated ‘AA’ dropped 0.62% in the same timeframe, due to the significant drop in Saudi Electric sukuk, which represents over 60% of the Dow Jones Sukuk AA Rated Total Return Index.  The shorter maturity indices also performed better than the longer maturity ones in 2015.  The Dow Jones Sukuk 3-5 Year Total Return Index rose 2.02% for the year (see Exhibit 2).

Exhibit 1: Total Par Amount of New Sukuk Issuances


Exhibit 2: Performance of the Dow Jones Sukuk Index Family in 2015


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