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In This List

Asian Fixed Income: The Philippines After the Key Overnight Rate Cut

ESG Integration for the Masses

The Walking Dead Return (as Active ETFs)

Calm After the Storm

Bank Lending: More Demand, Tighter Standards

Asian Fixed Income: The Philippines After the Key Overnight Rate Cut

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Michele Leung

Director, Fixed Income Indices

S&P Dow Jones Indices

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The Central Bank of the Philippines unexpectedly lowered the key overnight rate to 3% from 4% on June 3, 2016, as it shifted to an interest rate corridor system to “improve the transmission of monetary policy.”[1]  Sovereign bonds have had a strong rally since then; the total return rose 10.82% YTD, while the yield-to-maturity tightened 103 bps to 3.21%, according to the S&P Philippines Sovereign Bond Index as of Aug. 4, 2016.

The S&P Philippines Government Bond Index, which seeks to track the performance of sovereign bonds, government bills, and agency bonds, rose 10.58% in the same period.  Government bonds represent 89% of the overall fixed income market in the Philippines, with a total market value of PHP 4.3 trillion.

Additionally, the corporate bond market grew steadily over the 10-year period ending Aug. 4, 2016.  The three biggest corporate issuers are Ayala Land, Ayala Corp, and SM Prime Holdings.  Though the yield-to-maturity of the S&P Philippines Corporate Bond Index tightened 79 bps to 4.08% YTD, the yields remained attractive for the modified duration, at 4.06%.

The S&P Philippines Bond Index was the second outperformer YTD among the 10 Pan-Asian countries, delivering a 10.08% YTD total return as of Aug. 4, 2016.  The S&P Indonesia Bond Index was the best performer and gained 16.19% during the same period.

The Central Bank of the Philippines kept its benchmark interest rate unchanged on June 23, 2016, while indicating that average inflation is likely to settle near the lower edge of the inflation target of 2%-4% this year.  The next scheduled interest rate decision will be on Aug. 11, 2016.

Exhibit 1: The S&P Philippines Bond Index, S&P Philippines Government Bond Index, and S&P Philippines Corporate Bond Index 2016 YTD Total Return

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[1] Source: Bangko Sentral ng Pilipinas (BSP). Data as of May 16, 2016. http://www.bsp.gov.ph/publications/media.asp?id=4063

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

ESG Integration for the Masses

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Guido Giese

PhD, Executive Director, Head of Indices

RobecoSAM

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Historically, ESG indices have not attracted asset volumes comparable to smart beta index strategies.  This could be attributed to the fact that market participants and academics alike have struggled to link ESG-based strategies with financial performance.

As researchers shift their focus from how to study ESG to how to integrate ESG data into products and indices, two key issues related with integrating ESG data have come to light that may be the reason some market participants investors have held back from taking the plunge.

  • Aggregate ESG scores are highly correlated to existing allocation factors such as country, sector, or size and are even correlated to performance factors such as dividend yield and volatility. Therefore, the performance of any strategy or index that uses these ESG ratings as input will be dominated by these factor exposures, which has prevented these ESG ratings from being used as stand-alone performance factors.
  • ESG ratings are broad in the sense that they aggregate hundreds of ESG indicators into one single rating. This is in contrast to common factors such as value or momentum, which are based on just a few data points.  Integrating so many different indicators into an aggregate score creates the possibility of “diluting” a potential performance signal in the data, as some ESG indicators that do have performance potential will be aggregated with other indicators that are not necessarily linked to stock performance.

A new scoring approach called “Smart ESG” developed by RobecoSAM not only proves that ESG indicators can in fact be applied as stand-alone performance factors, but that they can also positively affect financial performance.

Smart ESG uses traditional ESG indicators as input, but it ensures that the aggregate score is uncorrelated to known factors and attributes the highest weight in the scoring process to those ESG indicators that have been found to predict stock performance, based on an in-depth and systematic factor testing of each individual ESG indicator per GICS® industry.

The outcome of this new scoring process is a set of so-called “ESG factor scores” that, when uploaded into a traditional factor model, show a positive information ratio of about 0.8 and are uncorrelated to all known factors.

This new ESG factor score is the basis of the new S&P ESG Index Series, a set of ESG indices launched in February 2016.  The S&P ESG Index Series includes the S&P 1200 Global ESG Index, S&P 500® ESG Index, S&P Europe 350 ESG Index, and the S&P/TOPIX 150 ESG Index.  This series is unique in the sense that it is the first global ESG index group that uses ESG as a smart beta factor.  These indices are weighted only by their ESG factor scores and show strong performance figures when compared to their market-cap-weighted counterparts (see Exhibit 1).

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Market participants may be attracted to these indices due to the possibility of receiving an attractive financial return while also receiving a “social” return by tilting their allocations toward more sustainable companies.  This is a major step toward making ESG integration even more accessible to a broader range of market participants.

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

The Walking Dead Return (as Active ETFs)

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Michael Mell

Senior Director, Custom Indices

S&P Dow Jones Indices

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In AMC’s “The Walking Dead,” we meet Rick Grimes after he awakens from a coma to find himself in post-apocalyptic world filled with legions of zombies.  Rick calls these zombies “walkers,” but as each season goes by (season seven starts this October) different groups name them other things, like biters, roamers, lurkers, etc.  The names don’t matter because there are more of them each day, all walking around aimlessly until they meet survivors in Rick’s group, who generally dispatch them efficiently.

In much the same way, active management is still losing out to passive index management, despite the numerous active funds that appear year after year.  According to the 2015 year end SPIVA® Europe Scorecard, which measures the performance of actively managed funds against their benchmarks, 84% of U.S. active funds underperformed the S&P 500 and an astounding 98% of U.S. active funds trailed their benchmark over the past 10 years.[1]  Interestingly, Moody’s recently found that the proliferation of funds is one cause for lackluster returns, as “there are more than 9,250 mutual funds and 10,000 hedge funds, compared with 3,691 stocks in the Wilshire 5000 and 505 stocks in the S&P 500®,”[2] and that this “overcapacity leads to investment mediocrity, since true talent is limited and size works against the investor in the form of increased transaction costs and difficulty in identifying scalable investment opportunities.”[3]

So what are all these active managers going to do?  Admit defeat and begin considering index-based solutions?  No—instead, the industry has decided to turn ETFs, arguably the most efficient vehicle for making low-cost, index-based solutions available, into a mechanism for spreading active management.  The walking dead are returning and there is no stopping them.

The SEC recently approved generic listing standards for actively managed ETFs, which currently “represent a small portion of the more-than $2 trillion invested in U.S. ETFs, with about $26 billion in assets, according to Morningstar Inc.  Still, the number of such funds sold has mushroomed to 154 this year from 40 five years ago and just 14 in 2008.  Actively managed funds have largely underperformed their passive rivals.”[4]  It’s important to understand that “the main distinction between active and passive, or index-based, ETFs is that the underlying holdings in the active ETFs are dynamic and managed similar to the way a mutual fund portfolio is managed.”[5]  To be fair, “sponsors of active ETFs say they are more attractive than actively managed mutual funds because they typically have lower management fees and feature a tax structure that makes them less costly than mutual funds.”[6]  Perhaps performance will improve only because the costs are lower?  However, even “after subtracting fees, returns from active management tend to be less than those from passive management.”[7]  Also, when thinking about active management in general, it’s key to note that “even when fund managers succeed in outperforming their peers in one year, they cannot easily repeat the feat in successive years, as many studies have shown.”[8]

So don’t expect these zombie active ETFs to come to life all of a sudden just because the wrapper for their active management approach is different.  Instead, you can expect to wake up one day like Rick Grimes and find that the more than 9,250 mutual funds and 10,000 hedge funds have been reanimated as active ETFs, most of whose strategies will likely continue to underperform passive investment management.

[1]  Year- End 2015 SPIVA® Europe Scorecard

[2]   Bloomberg News, http://www.fa-mag.com/news/more-pain-for-stock-pickers-as-moody-s-sees-big-shift-to-passive-28188.html?utm_source=FA+Subscribers&utm_campaign=19c5b45ee2-FAN_Mutual_Fund_News_072716&utm_medium=email&utm_term=0_6bebc79291-19c5b45ee2-222305257.

[3]   Ibid.

[4]   Ackerman and Sarah Krouse, http://www.wsj.com/articles/sec-set-to-fast-track-certain-etfs-1469209240.

[5]   Jeff Benjamin, http://www.investmentnews.com/article/20160728/FREE/160729936/active-etfs-produce-few-stars-and-even-fewer-fans.

[6]   Ibid.

[7]   SPIVA Institutional Scorecard–How Much Do Fees Affect the Active Versus Passive Debate?

[8]   Jeff Sommer, http://www.nytimes.com/2016/04/24/your-money/the-high-fees-you-dont-see-can-hurt-you.html?_r=1

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

Calm After the Storm

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Fei Mei Chan

Director, Index Investment Strategy

S&P Dow Jones Indices

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The dispersion-correlation map helps us to understand the dynamics of market volatility better. Last month we observed high levels of correlation in markets across the globe following the unexpected results of the Brexit referendum.

High correlation levels can be a reflection of market fragility. However, as current dispersion and correlation levels indicate, the heightened readings at the end of June resolved in a benign way.

S&P 500 dispersion is currently sitting near the lowest levels seen in 25 years. Correlation is also below average. In remarkable contrast to June 30th  readings, both dispersion and correlation have declined sharply for the S&P Europe 350. Dispersion, notably, is below average while correlation is not much above average. In Asia, the narrative is similar.

calm after the storm

There’s no telling which direction dispersion and correlation levels are headed but one definite implication of current low dispersion levels is that the market environment for active managers to add (or subtract) value is constrained.

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

Bank Lending: More Demand, Tighter Standards

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David Blitzer

Managing Director and Chairman of the Index Committee

S&P Dow Jones Indices

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Three times a year the Federal Reserve surveys bank lending officers about credit standards, loan pricing and the demand for borrowing.  The Survey provides insights into business and consumer borrowing as well as where the economy may be headed.  The results of the July 2016 survey, released today, echo the details in last week’s GDP report: consumers are spending money and helping the economy while business is not rushing to invest.

The first set of charts summarizes the Survey findings about Commercial & Industrial (C&I) loans, the principal part of bank lending to business.  The Survey measures results by the net percentage of banks reporting stricter credit standards, larger pricing spreads or increased loan demand. The C&I picture reveals a slight tightening of credit standards (top panel). The data show a small decrease in the pricing spread, the difference between the interest rates charged by the bank and the rate it pays for funds. Loan demand in the bottom panel shows a very small portion of banks reported increased loan demand compared to a net decline in the previous survey earlier in the year.

Bank lending in the residential mortgage market has been active.  The second set of charts shows changes in lending standards and loan demand for mortgages. Both these areas have been volatile and in both the housing boom and bust are easy to spot. Since the beginning of 2015, banks have been easing mortgage lending standards across all mortgage types except sub-prime.  For bankers, this may be the lesson of the financial crisis; for borrowers the lesson hasn’t been fully learned. The lower right hand chart shows that demand for sub-prime loans follows the other categories closely.  Some banks reported that they do not make sub-prime mortgage loans.

Another section of the report compares current credit standards to the average since 2005. Sub-prime borrowers seeking mortgages, auto loans or credit cards will find that standards are tighter today than typical since 2005; prime borrowers will find current standards are close to the average since 2005.

The charts are from the Federal Reserve July 2016 Senior Loan Officer Survey.

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