Indexology^® Blog

A detailed Wall Street Journal article today Markets in 2016: The Year of the Pig clearly shows that many asset classes are continuing to show volatility and negative returns however municipal bonds have been resilient. Tax-exempt investment grade municipal bonds tracked in the S&P National AMT-Free Municipal Bond Index up 1.24% year-to-date and high yield municipal bonds tracked in the S&P Municipal Bond High Yield Index up 1.13%.

Taxable municipal bonds however have jumped ahead as the S&P Taxable Municipal Bond Index has returned 3.59% year-to-date.  Relative to corporate bonds this segment of the municipal bond market has longer durations and higher coupons which both contribute to positive price movement as rates move down.

Table 1: Select bond indices, their yields and returns

Table 2: Select bond indices and key characteristics

Local and state municipal bonds issued within states dependent on oil production are potentially in a cycle where they could underperform the overall bond market. So far, modestly higher yields can be seen in Louisiana and North Dakota and only Louisiana has underperformed to any significant degree year-to-date.  Supply and demand of the bonds themselves plays an important role here as some states do not issue bonds in large volumes or have state supported debt.

Table 1:  Select municipal bond indices, their yields and year-to-date returns

Energy and Puerto Rico remain the sectors to watch as they continue to be drags on the bond markets.

Energy making this sector the lead ‘dog’ in performance so far in 2016. The S&P 500 Energy Corporate Bond Index is down over 4.8% year-to-date causing significant damage to the corporate bond markets as the index tracks over $289billion in par amount of bonds.

Table 1: Select bond indices, their yields and returns (YTD)

Puerto Rico municipal bonds have enjoyed a positive bounce in 2016 however the general obligation bonds are still a small anchor on performance of the high yield municipal bond market as the S&P Municipal Bond Puerto Rico General Obligation Index is down over 2% year-to-date.  This segment is a small anchor as the index tracks just over $11billion in par amount of general obligation bonds.

Years ago, I saw a cartoon picturing two Victorian-era doctors discussing a patient.  “What did you prescribe for Jones’ rheumatism?” asked the first; the second answered “A cold bath and a brisk walk every morning.”  “Good God, man, that will give him pneumonia!” said the first.  “I know,” replied the second doctor, “I made my reputation curing that.”

Somehow I was reminded of this exchange when I learned from this morning’s news that some institutional investors, smarting from recent losses, are considering increasing their commitment to active equity management.  Their operating assumption seems to be that active managers will do a better job of capital preservation in a challenging and volatile market.

There’s certainly some plausibility to this argument.  It turns out, however, to be another beautiful theory mugged by a gang of facts.  The facts come from our periodic SPIVA reports, which compare the results of actively-managed mutual funds against passive benchmarks.  Weak markets, it turns out, are no panacea for active managers.  In 2008, e.g., 54% of large-cap U.S. funds underperformed the S&P 500.  Results were even worse for mid- and small-cap managers (75% and 84% underperformers, respectively).

Statistics say, in other words, that moving from passive to active as a way of managing market volatility is likely to make performance worse, not better.  Fortunately for anxious investors, passive strategies which focus on the lowest volatility segment of the equity market are most likely to outperform precisely when the market is weakest.  Consider, for example, the S&P 500 Low Volatility Index and its cousin, the S&P 500 Low Volatility High Dividend Index:

Both of these indices are designed to attenuate the returns of the S&P 500 in both directions; historically they have both tended to underperform market rallies but outperform when markets are weak.  Their reliability as defensive vehicles has far exceeded that of active management.  Investors concerned about continuing volatility and market weakness should consider indicizing their defensive strategies.

Jan. 27, 2016 – A new 10-page study examines both the CBOE S&P 500 PutWrite Index (PUT) and the CBOE S&P 500 One-Week PutWrite Index (WPUT), comparing their performances with that of traditional benchmark stock and bond indexes. This is the first comprehensive published study that examines the performance of a benchmark strategy index that incorporates Weeklys options. Written by Oleg Bondarenko, professor of finance at the University of Illinois at Chicago, the study — “An Analysis of Index Option Writing with Monthly and Weekly Rollover”– analyzes the performance of the two indexes through the end of 2015.

The new paper discusses 19 Exhibits. In this Blog I highlight 5 of the Exhibits.

1. HIGHER AGGREGATE GROSS PREMIUMS USING S&P 500® WEEKLYS OPTIONS

CBOE introduced Weeklys options in 2005. In the initial years of Weeklys trading, it appeared to me that some observers thought that Weeklys might be used primarily by retail speculators, but in recent years I have heard from multiple institutional investors that they are writing S&P 500 Weeklys options for the purposes of prudent income enhancement. The new study found that, from 2006 to 2015, the average annual gross premium collected was 24.1 percent for the PUT Index and 39.3 percent for the WPUT Index. While a one-time premium collected by the weekly WPUT Index usually was smaller than a premium collected by the monthly PUT Index, the WPUT Index had higher aggregate annual premiums because: (1) premiums were collected 52 times, rather than 12 times, per year, and (2) time decay (or theta) usually works in favor of the WPUT Index vs. the PUT Index.

2. PUT INDEX HAD HIGHEST RETURNS SINCE MID-1986

In the period from mid-1986 through the end of 2015 –

• (1) The total % growth for benchmark indexes was 1622% for the PUT Index, 1499% for the S&P 500 Index, and 646% for the Citigroup 30-year Treasury Bond Index; (all of the indexes (except the VIX® Index) in this Blog are total return indexes), and
• (2) The annual compound return of the PUT Index was 10.13 percent, compared with 9.85 percent for the S&P 500 Index.

3. DRAWDOWNS WERE LESS SEVERE FOR PUT AND WPUT INDEXES (COMPARED TO S&P 500)

From 2006 through 2015, the worst drawdowns were down 24.2 percent for WPUT, down 32.7 percent for PUT and down 50.9 percent for the S&P 500.

4. HIGHER RISK-ADJUSTED RETURNS FOR PUT INDEX

Over a period of 29½ years, the PUT Index had higher risk-adjusted returns (as measured by the Sharpe Ratio, Sortino Ratio, and Stutzer Index) than the S&P 500, Russell 2000, MSCI World, and Citigroup 30-Year Treasury Bond Indexes. However, please note that many risk-adjusted return metrics assume a normal distribution with no skewness, but there was negative skewness for several indexes, including PUT (-2.09), S&P 500 (-0.79), and Russell 2000 (-0.89).

5. SOURCE OF RETURNS – RICHLY PRICED SPX OPTIONS

An inquiring investor might ask – how could the PUT Index have higher returns and lower volatility over a period of almost three decades? A key source of returns for sellers of SPX index options has been the fact that, according to Exhibit 5, these options have been richly priced in all the years since 1990 (except in 2008).

MORE INFORMATION

For links to the new paper and to several other options-based strategy papers, and to data and information on the PUT and WPUT indexes, please visit www.cboe.com/benchmarks.