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Why This New Way To Invest In Oil In Hong Kong Matters

Are employers' efforts to control healthcare costs futile?

Performance Analysis of Unconstrained Bond Funds

Buybacks, Dividends, Capex, and Long-Term Value Creation

Asian Fixed Income: What Does it Look Like Without India and China?

Why This New Way To Invest In Oil In Hong Kong Matters

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Jodie Gunzberg

Managing Director, Head of U.S. Equities

S&P Dow Jones Indices

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Now, there has been a long bull market where stocks have outperformed commodities for eight consecutive years, ending in 2015. It’s a record. If markets behaved just as they have in the past, then some investors might say it’s time to switch asset classes. However, the high correlation between risky assets experienced recently like during the recession of 2001-2003 and the global financial crisis in 2007-2009 has caused many investors to reconsider allocating by traditional asset classes defined by security type like stocks, bonds and real estate or commodities.

Instead, many investors are moving towards new techniques that define asset classes by their similarities in risk type.  For example, a risk-based allocation may use risk-buckets defined by growth, income, inflation and liquidity.  In the analysis of which assets protect against various risks, commodities, and in particular oil, float to the top of the inflation protection list.

Following the last time equities outperformed commodities for nearly as long from 1980-86, seven consecutive years, U.S. CPI year-over-year rose from 1.1% in Dec 1986 to 6.3% in Nov 1990, and commodities, as measured by the S&P GSCI Total Return index, returned almost 300% through that period.

The inflation sensitivity is high for commodities with an inflation beta near 15 for world production weighted indices (near 70% in energy) and closer to 10 for equally weighted indices with about 1/3 weighted in energy. This makes sense given it is the same food and energy in the indices that is in the CPI and that energy is the most volatile component so the more energy, the higher the inflation protection. Notice the big jump after 1987 – that came from adding energy into the index.

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

The need for inflation protection and diversification has created high demand for investment in oil. Especially since many emerging markets or newer ones to commodities feel more comfortable with a single commodity rather than the basket. For example, last August, the first ETF (exchange traded fund) on oil was launched in all of greater China out of Taiwan and now has over $300 million.

This is important since now their investors can benefit from the inflation protection and diversification provided by oil. The correlation to oil of many stock markets is only moderate at best.

Oil Correl Milken

Now is an exciting time for investors to gain this diversification and inflation protection in Hong Kong too.  On April 29, 2016, the very first ETF (exchange traded fund) on commodity futures will be listed in Hong Kong. Using monthly year-over-year data since 1987, the S&P GSCI Crude Oil has an inflation beta of 13.8 while the S&P 500 and Hang Seng Index only have inflation betas of 1.5 and 5.8, respectively. Also, the excess return of oil over the Hong Kong CPI is 7.2%, which is about the same as the excess return of their stock market but almost double the excess return from the S&P 500.

The oil can also offer some downside protection. For example, since 1987, on average when the HSI was negative in a month, it fell 5.6% but during those months, crude oil was basically flat, only dropping 0.2% and that’s not much worse than gold, the one considered the safe haven. Also, oil protects in many famous stock market drops like the Persian Gulf War and Black Monday.

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

Not only does this mark a new era of investment alternatives from traditional assets like stocks and bonds for investors to use in order to protect against portfolio risks but as investors allocate to commodities in local Asian markets, the futures growth may help standardize the quality of energy and food to make prices less volatile and their environment cleaner.

 

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

Are employers' efforts to control healthcare costs futile?

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Glenn Doody

Vice President, Product Management, Technology Innovation and Specialty Products

S&P Dow Jones Indices

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The question for the future of the private insurance system is this: are employers’ efforts to control healthcare costs futile?  Recent data from the S&P Healthcare Claims Indices would suggest that this may actually be the case.  According to the indices, costs for self-insured employers, known as Administrative Services Only (ASO) in the healthcare industry, are starting to increase again after showing declining cost trend levels from the 9% annual cost increases experienced in 2010.  To illustrate this concern, when we peer deeper into the recent data and look at hospital inpatient charges, we see an alarming trend.

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According to Exhibit 1, which looks at hospital inpatient costs, utilization, and average cost per day, employers have done remarkably well in controlling the utilization of services.  This decline in utilization can be attributed to many things, including increasing participant costs for inpatient services, the ongoing substitution of outpatient facilities for services formerly done on an inpatient basis, as well as better education among the users of these services.  However, what is evident is that even though utilization has declined since 2012, we have seen that average costs on the inpatient side have remained steady between USD 120 and USD 140 per member per month.  How is it that utilization or use of healthcare services could be falling, while at the same time average costs are holding steady?  The answer is evident in the average cost per inpatient per day index (unit cost) numbers.  Unit costs have been mirroring in reverse the drop in utilization.  This is a clear indication that as utilization drops, there is less revenue for service providers, and to compensate they have been increasing the fees charged for services to offset the revenue loss.  If this is the case, employers must ask themselves if future efforts to instill cost control are going to be met with the same results.

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

Performance Analysis of Unconstrained Bond Funds

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Hong Xie

Senior Director, Global Research & Design

S&P Dow Jones Indices

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Most unconstrained bond funds claim to offer the following potential benefits:

  • Low correlation to core fixed income;
  • Attractive risk-adjusted returns; and
  • Actively managed downside risk mitigation.

We examined each of these claims for the average performance of unconstrained bond funds since 2011 and noted that fund performance varied among them.

Persistently Higher Correlation to the Global Aggregate Bond Index Than the U.S. Aggregate Bond Index

Exhibit 1 shows the rolling two-year correlation of the average monthly return of unconstrained bond funds to that of the U.S. and global aggregate bond indices.  Though unconstrained bond funds do show periods of low, or at times negative, correlation to the U.S. Aggregate Bond Index, they also tend to demonstrate persistently high correlation of above 0.50 to the Global Aggregate Bond Index, though only until 2014.

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Lower Risk-Adjusted Returns Than the U.S. Aggregate Bond Index on Average

Exhibit 2 shows the risk/return profile of unconstrained bond funds versus the U.S. and global aggregate bond indices.  On average, unconstrained bond funds delivered lower return and lower return per unit of volatility than the U.S. Aggregate Bond Index and higher return than the Global Aggregate Bond Index.  As average returns across funds tend to smooth out performance volatility due to the imperfect correlation between these funds, we also charted the performance statistics for quintile portfolios by return for the 36 funds that had full performance data for our analysis period.  Only one out of the five quintiles demonstrated a higher annualized return than the U.S. Aggregate Bond Index, and none outperformed the U.S. Aggregate Bond Index in terms of return per unit of volatility.

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Improved Drawdown

Exhibit 3 shows the maximum drawdown for unconstrained bond funds versus the core fixed income indices for the analysis period.  On average, unconstrained bond funds experienced a maximum drawdown of 3.02%, which was better than the U.S. Aggregate Bond Index and the Global Aggregate Bond Index.  Exhibit 3 demonstrates the variance in maximum drawdown across all funds.  On average, at least 60% of funds experienced worse maximum drawdown than the U.S. Aggregate Bond Index.

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

Buybacks, Dividends, Capex, and Long-Term Value Creation

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Kelly Tang

Director

Global Research & Design

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This is the fourth and final in a series of blog posts relating to the launch of the S&P Long-Term Value Creation (LTVC) Global Index.

In our recent paper “Long-Termism Versus Short-Termism, Time for the Pendulum to Shift?” we discussed reasons why short-term corporate behaviors persist in developed economies.  One of the key drivers was the immense pressure that company management teams are under to deliver on earnings, especially at the expense of long-term strategic investment.  Looking at how companies in the S&P 500® were dispensing cash flow does indicate a worrisome trend: capital expenditures as a percent of operating cash flow continue to trend downward, and for 2015, it was 42% compared to its 30-year historical average of 56% (see Exhibit 1).  The decline represents a secular trend, with average capex as a percent of operating cash flow falling from 69% in the 1990s to 51% in the 2000s and 40% in the 2010s.  While technological advances and efficiencies can certainly be a factor in driving down capex investment, it seems somewhat implausible as an explanation for a 30% drop in over 20 years.

Conversely, buybacks and dividend payments together comprised 59% of operating cash flow, versus their historical average of 46%, or almost USD 990 billion in total shareholder return (see Exhibit 2).  A question arose as to how companies are funding this level of buyback and dividend activity, and a review into S&P 500 companies’ finances showed that companies have the operating cash flow resources to support these expenditures.  However, given the low-interest-rate environment, we thought it would be interesting to look at debt issuance.  New debt issued has rebounded sharply from the low in 2010 after the financial crisis; S&P 500 companies issued USD 1.8 trillion in debt in 2015, which is below the record USD 2.5 trillion issued in 2007 but also represents the highest amount issued since that period (see Exhibit 3).  Overall, corporate balance sheets are healthier and interest rates are low, but it does highlight the continuing corporate short-term behaviors taking place, whereby companies are borrowing record amounts not to invest in capital expenditures or assets that can generate future earnings, but instead to pay back shareholders today.

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Pleasing current shareholders seems to be an overriding priority for companies, with record amounts returned to shareholders at the expense of capital investment and increased debt.  In the previously mentioned paper, we discussed the rise of the activist investors and how their growing influence has increased corporate short-termism.  In addition to the S&P Long Term Value Creation (LTVC) Global Index, S&P DJI also created the S&P U.S. Activist Interest Index, and despite the caveat that one is a global index while the other is a U.S. index, it is interesting to track the performance of these two indices over the five-year period from March 2011 to March 2016.  As shown in Exhibit 4, the results were equal as of March 2016, and yet S&P LTVC Global Index proved to be much less volatile.  Perhaps slow and steady does win the race.

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

Asian Fixed Income: What Does it Look Like Without India and China?

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Michele Leung

Director, Fixed Income Indices

S&P Dow Jones Indices

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According to the S&P Pan Asia Bond Index, India and China together represented 79% of the overall market value as of April 18, 2016.  While foreign investor access to these countries is opening up, the investability is still limited.  The market value excluding these two countries is around USD 2 trillion, as tracked by the S&P Pan Asia Ex China and India Bond Index, and Korea has the biggest exposure (see Exhibit 1).

Looking at historical performances, the S&P Pan Asia Bond Index outperformed the S&P Pan Asia Ex China and India Bond Index over the past one-, three-, and five-year periods, reflected the robust returns in the Indian and Chinese markets in recent years.  However, the trend has been reversing in 2016 and the S&P Pan Asia Ex China and India Bond Index increased 5.65% YTD, as of April 1, 2016. Interestingly, the S&P Pan Asia Ex China and India Bond Index also demonstrated higher volatility in the past 5 years (see Exhibit 2).

Exhibit 1: Country Breakdown of the S&P Pan Asia Ex China and India Bond Index

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