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How Benchmark Selection Can Support a Retirement Plan’s IPS

Looking at the Low Beta and Value Legs of the S&P GIVI® Japan

Asian Fixed Income: Sovereign Yields

The Payroll Surge and the Fed

Indexing Alternatives To Survive Brexit

How Benchmark Selection Can Support a Retirement Plan’s IPS

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Philip Murphy

Managing Director, Global Head of Index Governance

S&P Dow Jones Indices

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Sponsors of 401(k) plans sometimes do not approach the selection of capital market benchmarks as if it has a significant role to play in the implementation of their investment policy statements (IPSs).  They may leave benchmark selection to investment managers, consultants, or service providers, but in so doing they may be missing an opportunity to enhance plan oversight and administration.

According to Ian Kopelman, Chair of the Employee Benefits and Executive Compensation Practice at DLA Piper, an IPS of defined contribution retirement plans ought to include several key elements.[1]  Among them are the following.

  • Describe the purposes and general investment objectives of the plan: Fulfillment of a plan’s purpose is interconnected with its investment objectives, which in turn should be measured against appropriate capital market-based benchmarks. For example, if a plan aspires to provide default investment options that transition from wealth accumulation to income risk mitigation, then such an investment strategy ought to be measured against an appropriate benchmark.
  • Describe the asset classes to be offered and the factors for selecting investment options, such as risk/return characteristics, expenses, and benchmark comparisons: Multi-asset class investment products, such as target date and balanced funds, are now the most widely adopted default solutions within 401(k) plans. These products typically have a mandate to deliver full-fledged investment programs that cannot be robustly measured against single asset class benchmarks.  It is more important than ever to develop a methodical framework to benchmark selection in light of the dynamic, complex nature of modern default investment alternatives.
  • Describe standards for investment performance and criteria for measuring performance: One of the deeper issues around investment performance is benchmark appropriateness. Too often, a great deal of time and energy is spent on performance analytics, but a lack of benchmark due diligence results in flawed analysis.  In other words, an IPS can describe standards and criteria for investment performance, but if a selected benchmark is not appropriate for the investment strategy, the analysis is flawed from the outset.
  • Describe the process and standards for selecting a qualified default investment alternative (QDIA): No other investment selection has as much potential impact on a plan’s participant population as the QDIA choice. So it is singularly important to select an appropriate benchmark for the QDIA.  Within the overall target date category, the S&P Target Date Indices offer industry-wide benchmarks that represent a consensus view of target date managers.  S&P DJI offers the static S&P Target Risk Indices that may serve well as benchmarks for balanced funds.  For target date income funds, a new category that seeks a transition and a balance between growth and the mitigation of income affordability risk, the S&P STRIDE Indices may serve well as the benchmark of choice.

Far from being merely incidental in the investment monitoring process, benchmarks play a vital role in the implementation of a retirement plan’s IPS.  However, for their true value to be realized, a thoughtful approach to benchmark selection is essential.

[1] See “Investment Policy Statements: Think Art, Not Science” at http://dimensional.com/media/350682/3-Investment-Policy-Statements.pdf

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

Looking at the Low Beta and Value Legs of the S&P GIVI® Japan

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Tianyin Cheng

Senior Director, Strategy and Volatility Indices

S&P Dow Jones Indices

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The spread between the returns of the S&P GIVI Japan and its benchmark index, the S&P Japan BMI, comes from three sources: the excess return of the S&P Low Beta Japan Index; the excess return of the S&P Intrinsic Value Weighted Japan Index; and a residual effect that comes from the sequential approach to the index’s construction.  Looking at the low beta and value legs individually may help market participants to understand the performance of the S&P GIVI Japan better.

Performance

The S&P Low Beta Japan Index and the S&P Intrinsic Value Weighted Japan Index outperformed the S&P Japan BMI by 2.42% and 2.79%, respectively, over the period from Dec. 31, 1999, to June 30, 2016.  Over that time period, however, there were cycles in the performance of the two legs and the correlation coefficient.

Exhibit 1 provides a visual illustration of the relative performance of the two legs versus the S&P Japan BMI.  The value premium seems to be compressed in Japan over time.  We see for the first time in June 2016 that the S&P Intrinsic Value Weighted Japan Index underperformed the S&P Japan BMI over a rolling five-year period.  The low beta leg tended to outperform during down markets and underperform during up markets.  In the bull markets from 2H 2012 to 1H 2015, however, the low beta leg had a counterintuitively strong performance.  The low beta leg continued to do well when Japanese equity markets were down, starting from 2H 2015.

Please refer to S&P GIVI Japan and Major Single Factors from July 2016 for a performance analysis since the launch of the indices.

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Correlation

Exhibit 2 shows the rolling three-year correlation coefficient between the two legs.  The full period correlation coefficient between the two legs is 0.35.  Over the seven-year period ending June 30, 2016, there seems to have been a much lower correlation (-0.15).  Given the performance of these two legs since end of 2012, the correlation between them has declined dramatically.  As of June 30, 2016, the correlation was at -0.54, the lowest level since the end of 1999.

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Valuation

The recent performance also significantly pushed up the valuation of the S&P Low Beta Japan Index.  As shown in Exhibit 3, the S&P Low Beta Japan Index was priced at 15.41x projected earnings and 1.30x book value as of June 30, 2016.  This was much higher than the 13.63x and 1.12x, respectively, of the benchmark, the S&P Japan BMI.  We should note that the valuation of the S&P GIVI Japan was still more favorable compared with the benchmark.

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

Asian Fixed Income: Sovereign Yields

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Michele Leung

Director, Fixed Income Indices

S&P Dow Jones Indices

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The story of Asian fixed income remains compelling, and select Asian bond markets recorded strong growth and solid performance in 2016.  Most Asian currencies strengthened with the news of the Brexit, which may further improve sentiment among market participants.  Asian bond yields, though tightened, are still at an elevated level compared with their global peers.  Particularly in this global low-to-negative interest rate environment, Asian bonds are attractive, as the theme of yield hunting continues.

Looking into the 10 countries in the S&P Pan Asia Sovereign Bond Index, the highest-yielding market was India (at 7.50%), followed by Indonesia (at 7.40%), see exhibit 1.  In fact, the S&P Indonesia Bond Index was the outperformer in the region in 1H 2016, delivering 12.90% total return YTD as of July 7, 2016.  The S&P BSE India Bond Index gained 5.99% during the same period.

The yield-to-maturity of the S&P China Bond Index was 2.79%; it was the highest among the Asian countries rated ‘AA-.’  Yet the total return index only added 1.73% YTD, making it the second–worst-performing country in the Pan Asia region.

The S&P Hong Kong Bond Index was the underperformer, as it was up 0.67% YTD.  Its sovereign yield was 0.53%, which also the lowest among the 10 countries.

Exhibit 1: Asian Sovereign Yields

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

The Payroll Surge and the Fed

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David Blitzer

Managing Director and Chairman of the Index Committee

S&P Dow Jones Indices

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Payrolls jumped with 287,000 new jobs in today’s employment report sparking a stock market rally that boosted the S&P 500 to within five points of a new record high and renewed questions about a Fed rate hike. The employment report was welcome and put to rest worries that the labor markets were weakening. However, the Fed is likely to remain on hold until the fourth quarter or longer. Even with this report, job growth is easing a bit: over the last three months job growth has averaged 147,000 per month compared to 199,000 per month over the 12 months through June.  The labor force participation rate and the employment population ratio remain flat; the unemployment rate ticked up to 4.9%.  Labor market conditions look better than they did before the report, but the overall picture is little changed.

Source: Employment Situation Report, Bureau of Labor Statistics
Source: Employment Situation Report, Bureau of Labor Statistics

The big cloud on the horizon is neither the labor market nor inflation – it is the expected fallout from Brexit.  From the last FOMC minutes it is clear that the Fed, like almost everyone else, is trying to figure out what happens next in Great Britain and Europe. A few things can be identified and are likely to discourage any early Fed action to raise interest rates. First the dollar’s strength may dampen US exports and put further downward pressure on inflation, deterring any thoughts of a rate hike. The larger concern is that financial markets may react the way they did when the vote was announced, adding to uncertainty and volatility. Moreover, Brexit may be dominating the headlines but there are other issues across Europe with concerns about debt levels and banks. All this suggests that stable monetary policy is a better choice than trying to raise interest rates.

For investors and the Fed it is a wait and see game. Those who like rock bottom interest rates are likely to enjoy them for a while longer.

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

Indexing Alternatives To Survive Brexit

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Jodie Gunzberg

Managing Director, Head of U.S. Equities

S&P Dow Jones Indices

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Following the vote by UK citizens to officially leave the European Union, the S&P 500 lost 5.3% in 2 days (Jun. 24-27, 2016) before gaining back 4.5% for a total loss 1.1% through July 5.  In those two down days, gold posted its best consecutive 2-day gain since Aug. 8-9, 2011.  Gold is known as a safe haven and was worth its weight on those fearful days, but on a stand alone basis, it is just as volatile as equities and other commodities. Its 10-year annualized volatility is 19.5%, that is just slightly less than the 20.5% of the S&P 500 and 23.8% of the S&P GSCI. Moreover, gold’s volatility is higher than the equally weighted Dow Jones Commodity Index (DJCI) of 17.9% and the “smart beta” Dow Jones RAFI Commodity Index of 16.4%.

While indexing has evolved to offer concentrated exposures to particular sectors or single commodities so investors can choose to invest or benchmark to a specific niche, many investors still prefer the diversification inside an index. However, just because an index is well-diversified it does not need to be exposed to systematic risk of the S&P 500 or market events like Brexit.

There is a group of well-diversified indices that didn’t just lose less than the S&P 500 or S&P GSCI, but posted gains in the 2-day crisis. The strategic futures index family is designed to represent the global macro and managed futures/Commodity Trading Advisor (CTA) universe by using quantitative methodologies to track the prices of a globally diversified portfolio of commodity, foreign exchange and financial futures contracts. All three flagship indices in the family, the S&P DFI, S&P SFI and S&P SGMI, gained on Jun. 24-27, 2016, 0.8%, 1.0% and 2.2%, respectively.

Not only did these three perform positively through the stock market decline but they held onto their gains for an overall positive return while stocks rebounded.  They didn’t rebound as much as the 4.5% gain from the S&P 500 but the S&P SGMI gained 1.8% while the S&P SFI and S&P DFI lost just 10 and 70 basis points.  Overall through the 7-day period, when the S&P 500 lost 1.1%, the S&P SGMI gained 4.0%, S&P SFI gained 1.0% and S&P DFI was up 0.1%.

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

These strategies performed exactly how intended with downside protection and less upside for a total return with less volatility and capital preservation.  The 10-year annualized volatility of the S&P SFI is just over a quarter of the S&P 500. The S&P SGMI, which is the most volatile of the family is still only about half as volatile as the stock market, and annualized over the past 10 years provided a comparable return of 7.1% versus 7.4% of the S&P 500.

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

It may be surprising that these strategies use commodities, but in a diversified framework like in the S&P Real Assets Index and smarter commodity strategies like in the Dow Jones RAFI Commodity Index, the strategic futures that go beyond just commodities can provide an attractive hedge to stock market volatility without the high concentration risk of sectors or single commodities.

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