Investment Themes

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The Price of Retirement

Driving long-term value creation

Latest Healthcare Cost Analysis Shows Individual Market Trends in Line With Employer Trends! – Part 1

It’s Now Easier to Strengthen Your Core With Municipal Bonds

Are You Looking for Outperforming Funds?

The Price of Retirement

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Philip Murphy

Managing Director, Global Head of Index Governance

S&P Dow Jones Indices

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In my last post, I discussed variability in cost and affordability of retirement income.  I used some data from S&P STRIDE, our new benchmark that provides a cradle-to-grave yardstick for wealth accumulation and income generation.  This week, I will look a little closer at how we measure retirement income, as well as its present value or cost.  To begin with, defined contribution retirement plan participants and IRA investors must convert their accumulated savings into an income stream when they enter retirement.  Things may be simpler for people with defined-benefit pensions that pay out monthly benefits according to the plan’s vesting schedule and benefit formula.  However, even though defined benefits are expressed as monthly income, they have a present value, which is simply the stream of their expected future cash flows expressed as a discounted lump sum.

If you were to ask people of my parent’s generation, “What is your net worth?” they probably would not count the present value of their pension benefits.  They may view it as part of their personal income statement but not their balance sheet.  However, if you asked people in my generation the same question, I bet they would include the value of their 401(k).  They are thinking of it as a balance sheet item, but many have not yet considered that it needs to become an income statement item upon retirement.

When considering the convertibility of lump sums into income streams and vice versa, it may help to think about how the bond market works.  When you buy a bond, you convert a given amount of liquid funds into future cash flows, and when you sell a bond, you convert future cash flows into readily available capital.  As we know, bond prices vary with interest rates, and the same applies to future retirement income.  The bond market analogy is relevant because at S&P DJI, we calculate the value of retirement income exactly like the value of a bond.  However, we define a special “bond” called the generalized retirement income liability (GRIL) as a particular set of cash flows.  Specifically, GRIL is defined as USD 1 per year of inflation-adjusted income starting at age 65 and continuing for 25 years.  We discount GRIL’s cash flows using the U.S. Treasury Inflation-Protected Securities (TIPS) yield curve.  This results in a transparent, precise method for evaluating the cost of future inflation-adjusted (real) income.  We calculate the present value of GRIL for various starting points, each corresponding to specific target years within the S&P STRIDE Indices.  Currently, they range from 2005 to 2060.  For example, if you plan to retire around 2035, you can find the cost of retirement income as we calculate it on our website under the “additional info” menu.  Exhibit 1 shows the cost of 2035 GRIL since January 2016:

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What does Exhibit 1 tell us?  GRIL is 25 US dollars of inflation-adjusted retirement income spread over 25 years—USD 1 per year.  To buy that income stream at the end of January 2016 would have cost USD 17.40, but as of September 2016, its cost increased to USD 20.68.  Therefore if you held $1 million in US T-Bills (potentially the safest investment one can find, from the perspective of investment volatility), in January 2016, you could have acquired $57,471 of today’s US dollars per year starting in 2035 and lasting until 2060.  The calculation is USD 1 million / USD 17.40.  However, because real interest rates trended down since the start of the year, increasing the cost of income, as of September 2016 that same $1 million T-Bill portfolio would only have bought $48,356 of future income (USD 1 million / USD 20.68).  When viewed through the lens of income affordability, it is therefore clear that investing in T-Bills and other short-term obligations is not risk free.

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

Driving long-term value creation

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Manjit Jus

Head of ESG Ratings

RobecoSAM

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The annual rebalancing of the Dow Jones Sustainability Indices (DJSI), the most famous benchmark for corporate sustainability in the world, took place on September 8th 2016. With nearly 2,000 companies analyzed currently and another nearly 2,000 to be analyzed in RobecoSAM’s 2016 Corporate Sustainability Assessment (CSA), it is clear that sustainability is no longer something “nice to have,” but rather a necessity in order to remain cutting-edge. Likewise, the growing number of requests for new indices proves that there is appetite for fresh products among investors. At the core of this positive trend is the recognition that long-term sustainability factors are the key to long-term value creation. This has set the stage for exciting new developments.

S&P Long-Term Value Creation Index
RobecoSAM had the opportunity to work together with the Canada Pension Plan Investment Board (CPPIB) a leading supporter of the long-term investing movement. The belief that sustainability is by definition something that can and will play out over a long time horizon also attracted the interest of S&P Dow Jones Indices. The result was the S&P Long-Term Value Creation Index, an innovative product that has garnered much investor attention. This index focuses not only on the long-term financial viability of a company, but also on its sustainability performance.

New questions
RobecoSAM introduced a number of new questions to its CSA in 2016, including questions on the sources of long-term value creation, how goals are aligned with remuneration, and how transparent companies are in discussing progress towards sustainability goals. These new questions, found within the new “Materiality” criterion, were the product of discussions about what the sources of long-term management creation really are.

Impact measurement
Another area of development in this year’s CSA was impact measurement. While the term has gained traction within the investment community, impact measurement is often backward-looking. Thus, the “Impact Measurement & Valuation” criterion introduced in the CSA rests on major global drivers such as the United Nations Sustainable Development Goals (SDGs). These goals provide companies and investors with a compass to steer their sustainability initiatives towards global challenges. RobecoSAM regards these goals as essential for companies to ensure that they are generating value for all stakeholders. As investors also begin to align their strategies towards the UN SDG’s, companies that can demonstrate they are thinking long-term will have the upper-hand.

Conclusion
Looking back over 2016, we can see that progress has been made to encourage long-term strategies among companies and investors. But more work needs to be done. With new products like the S&P Long-Term Value Creation Index, the JPX/S&P CAPEX & Human Capital Index, the S&P DJI Fossil-Fuel Free index series and the Dow Jones Sustainability Indices, we have taken steps towards offering investment opportunities focused on long-term sustainability themes. RobecoSAM believes that creating long-term value and solving the world’s biggest sustainability challenges are not things that should be tackled in isolation, but rather tackled at both ends, where investors and companies each do their part to ensure a viable future.

Legal Information: The information and opinions contained in this publication constitutes neither a solicitation, nor a recommendation, nor an offer to buy or sell investment instruments or other services, or to engage in any other kind of transaction. RobecoSAM AG and its related, affiliated and subsidiary companies disclaim all warranties, expressed or implied, including, but not limited to, implied warranties of merchantability and fitness for a particular purpose. In no event shall RobecoSAM AG and its related, affiliated and subsidiary companies be liable for any direct, indirect, special, incidental or consequential damages arising out of the use of any opinion or information expressly or implicitly contained in this publication. © 2016 RobecoSAM AG.

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

Latest Healthcare Cost Analysis Shows Individual Market Trends in Line With Employer Trends! – Part 1

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Glenn Doody

Vice President, Product Management, Technology Innovation and Specialty Products

S&P Dow Jones Indices

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There are many in the healthcare market who have speculated that the Affordable Care Act (ACA) was doomed to fail due to high-cost individuals with pre-existing conditions driving up the average cost of care, while the healthy population that needed to support the cost of care for the sick remained on the sidelines with little-to-no incentives to become insured.  The S&P Healthcare Claims Indices supported this theory throughout 2015, when the average cost of care for a patient with an individual health insurance policy topped out at USD 415.15 versus USD 388.70 for an employee covered under an ASO type policy by their employer, or USD 338.92 for an employee covered under a large group type policy by their employer (see Exhibit 1).  That is, USD 26.45 more to treat a patient covered by an individual policy versus a self-insured type policy, and a whopping USD 76.23 more to cover an individual policy patient versus a patient covered by a large group policy by their employer.  Under both the self-insured and large group structure, the employer requires all employees to maintain insurance, which in effect forces a suitable population of healthy people to pay for unhealthy people.

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What Has Changed?

As seen in Exhibit 1, we can see a drop in the average cost of care for a patient covered under an individual policy starting in 2016.  Now that costs for individual policies are in line with those of employers, one can argue that this is how the ACA was envisioned to work.  With everybody having access to care, everybody paying their fair share, average costs should be in line with that of the overall market.  However, a more in-depth study is needed to understand the reasoning behind individual policy costs coming in line with the employer market.  We envision several potential reasons for the larger drop in average costs relative to the employer market.  In this edition, we will focus on one possible explanation.

When plan enrollees approach the end of a plan year, they often review their total out of pocket costs for that given year.  In a year where plan members have hit their maximum out of pocket costs, they are more likely to continue to spend and try to get all elective health issues addressed in the current year rather than carry them over to the next plan year where their maximum out of pocket costs will reset.  If we think about how the ACA enticed many uninsured individuals with pre-existing conditions to enter the market, buy insurance, and utilize that coverage to address their existing needs, it only makes sense that they will try to address all of their pre-existing conditions in the same plan year to avoid unnecessary out of pocket expenses.  If this is the case, then 2015 should be an anomaly, and moving forward we should see average individual costs stay in line with employer costs, assuming the ACA is working the way it was intended to work.

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

It’s Now Easier to Strengthen Your Core With Municipal Bonds

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Shaun Wurzbach

Managing Director, Global Head of Financial Advisor Channel

S&P Dow Jones Indices

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We all know we should work on and improve our core, but how many of us have the discipline to do it?  I interviewed two financial advisors who are strengthening their core by using municipal bond indices and the ETFs that track them.

Matt Papazian is founding partner and CIO at Cardan Capital Partners of Denver, Colorado, and Tom Cartee is a financial advisor and portfolio manager at Sheets Smith Wealth Management of Winston-Salem, North Carolina.

S&P DJI: Has the availability of indices or beta for municipal bonds changed the way that you are able to use municipal bonds?

Matt: Yes.  The ability to move weightings seamlessly between credit and duration is a great benefit of these new offerings.  We are now able to access the high-yield municipal bond space with ease, something we would not normally do with individual bonds.  Because of the historically low default rate in the municipal bond space, including high-yield bonds, we view access to different segments of the municipal bond market as an integral part of how we invest.

Tom: I agree with Matt.  I like to use equity ETFs based on broad indices as the core building blocks of client portfolios.  Municipal bond ETFs enable me to use a similar low-cost, broadly diversified approach to fixed-income allocation within taxable accounts.

S&P DJI: We’ve observed robo-advisors using core municipal bond ETFs within even the most basic asset allocations and at every level of client investment.  Are you finding it easier to deliver this asset class to the smaller clients you work with?

Matt: For smaller market participants, ETFs provide a substantially more efficient way to invest in tax-free bonds.  Small trades in bonds are generally quite expensive for small market participants, even if they don’t see the fee, so ETFs have leveled the playing field for them.

Tom: Trading small lots of individual municipal bonds is not very efficient.  The liquidity available with municipal bond ETFs offers a compelling reason to emphasize ETFs over individual bonds in smaller accounts.

S&P DJI: What are your thoughts on combining index-based municipal bonds with individual municipal bonds?

Matt: Although the majority of our municipal bond investing is done with ETFs, we view individual bonds as a valid way to get exposure to the space for larger investors, but we prefer ETFs for their liquidity and low transaction cost.  We also avail ourselves of closed-end funds when the values are compelling.

Tom: Again, I agree with Matt.  ETFs offer many advantages.  Because tax rates vary from state to state and liquidity needs vary among market participants, advisors may decide to use municipal bond ETFs alongside individual bonds in certain accounts.  The key is to recognize that municipal bond ETFs can be the core, given their favorable characteristics.

My thanks to Matt and Tom for participating in this interview and in a recent webinar on core municipal bond investing that is now available in our webinar archive.

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

Are You Looking for Outperforming Funds?

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Priscilla Luk

Managing Director, Global Research & Design, APAC

S&P Dow Jones Indices

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When one is paying management fees for the investment in active funds, one might reasonably expect the funds to outperform benchmarks and resist downturn when the market is volatile.  However, results from our S&P Indices Versus Active (SPIVA®) Scorecards[1] suggest this expectation is often not met.  SPIVA reports across different regions, including the U.S., Canada, Europe, Mexico, Chile, Brazil, South Africa, Australia, Japan, and India, show that benchmark indices outperformed the majority of their comparable actively managed funds over the five-year period ending June 30, 2016.

Since we published the first SPIVA Australia Scorecard in 2009, we have observed that the majority of Australian active funds in most categories have failed to beat comparable benchmark indices over three- and five-year horizons (with the exception of the Australian Equity Mid- and Small-Cap category).  As of June 2016, 69% and 38% of Australian Equity General (large-cap) and Mid- and Small-Cap funds underperformed the S&P/ASX 200 and S&P/ASX Mid-Small indices, respectively, over the five-year period.  The results for Australian Equity A-REIT, Australian Bonds, and International Equity General fund categories were far more disappointing; 92%, 89%, and 92% of funds in the three categories lagged their respective benchmark indices, respectively.

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Though only a small portion of funds beat the benchmark indices in most fund categories, one might still attempt to find those outperforming funds.  However, based on our performance persistence analysis on Australian active funds, it is extremely challenging to pick winning streaks, as we found that few Australian active funds were consistent top performers.

Out of 181 top-quartile Australian active funds selected as of June 2012, only three (1.7%) managed to remain in the top quartile by June 2016.  There were 75 Australian large-cap equity funds and 13 Australian bond funds in the top quartile in June 2012, but just 2.7% (two funds) and 7.7% (one fund), respectively, remained in the top quartile four years later.  None of the top-quartile candidates from the Australian Equity Mid- and Small-Cap, Australian Equity A-REIT and International Equity General categories managed to stay in the top quartile over the next four consecutive years.

Similar results were observed in the performance consistency analysis of U.S. active funds over consecutive years.  According to the S&P Dow Jones Indices Persistence Scorecard: August 2016, less than 1% of U.S. domestic funds that began as top-quartile performers in March 2012 ended up in the top quartile almost four years later.  This indicates that actively managed funds may have difficulty remaining in the top quartile over a five-year period.

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Based on results from the SPIVA Scorecards, identifying outperforming active funds is no easier than selecting winning securities.  While there are decades of research on factor-based or trading strategies attempting to beat the market, there is much less analysis and research on selecting outperforming funds.  Considered together with the observed inconsistency of active fund performance, finding funds that beat the benchmark for several consecutive years may appear an inconceivable mission.

[1]   Twice a year, we publish SPIVA Scorecards, which track the number of active funds that beat their comparable benchmarks over one-, three-, and five-year timeframes in different regions.

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