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Passive Investing – Myth or Reality? Part 1

S&P GSCI Rebalance Triggers Brent Outflows 8X Bigger Than For WTI

The Source of Uncertainty

Dow Jones Industrial Average® 2016 Year in Review

Year in Review: 2016 Asset Class Performance

Passive Investing – Myth or Reality? Part 1

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Koel Ghosh

Head of South Asia

S&P Dow Jones Indices

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Indexing is certainly not a myth, and while active investing is a popular reality in Indian markets, we are seeing the slow and steady rise of indexed products.  In a recent article, John C. Bogle, the founder of Vanguard Group, said, “We are in the middle of a revolution led by indexing.”[1]  John C. Bogle’s first index fund was launched in 1976, and Vanguard is among today’s top global ETF providers.

Revolution indeed; when we see the global ETF assets at over USD 3 trillion, there is no doubt that this space has seen exponential growth.  However, there is no argument against the fact that active management can be successful.  Advocates of active management argue the ability to outperform benchmarks is what supports their claim on the supremacy of the active play.

However, the question is not whether active management is successful, but rather for how long it is persistently successful.  So first, let’s review the outperformance of benchmarks.  This brings us to review whether the appropriate benchmark is being followed.  “Appropriate” is an important qualifier—among other things, it means that the benchmark should be consistent with the manager’s portfolio selection style.  To explain this further, a thematic investment portfolio (e.g., for a dividend fund) should ideally be compared to a dividend index rather than a generic market benchmark like the S&P BSE SENSEX or the S&P BSE 200.  This ensures that there is an apples-to-apples comparison.  This also ensures that market participants are comparing similar universes; hence the “appropriate” comparison.

In the passive world, since the market participants own a proportionate slice of the index, they are earning the index returns less fees and expenses.  In other words, the investment and its objective are aligned directly with the index.  There should be no subjectivity or doubt as to how the index and its benchmark are aligned.

Hence, the first step to ensure that we are measuring active performance appropriately is to check if the investment strategy or product is appropriately benchmarked.  That then provides us with the “real” picture.

[1]   ET, Bloomberg, Nov. 25, 2016.

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

S&P GSCI Rebalance Triggers Brent Outflows 8X Bigger Than For WTI

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Jodie Gunzberg

Managing Director, Head of U.S. Equities

S&P Dow Jones Indices

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The S&P GSCI annual rebalancing is beginning today to adjust the commodity weights to their 2017 target weights over the next five days.  Energy remains the biggest sector in the index in 2017, targeting 56.2%, despite a significant decrease from its 2016 target weight of 63.1% and ending weight on Jan, 6. 2017 of 62.2%. In fact, it is the lowest target weight for energy since 1999, driving $600 million of energy outflows for every $10 billion tracked.

Source: S&P Dow Jones Indices. Red bars show target weights and blue bars show actual. Note in 2015 and 2016, the market was falling during the rebalance, so the actual weights never reach the target at the end of the rebalance period.
Source: S&P Dow Jones Indices. Red bars show target weights and blue bars show actual weights. Note in 2015 and 2016, the market was falling during the rebalance, so the actual weights never reached the target at the end of the rebalance period.

One way to look at the results is simply by the weight (Reference Percentage Dollar Weight found on page 11 of the methodology) but most traders want to know how much money is moving as a result of the rebalance to the new target weights.  While the table below shows the dollars that will move for every commodity from the rebalance for every $10 billion tracking the S&P GSCI, the biggest shift is away from brent crude with an estimated $313.7 million flowing out by the end of the rebalance.  It is 8 times bigger than the $39.3 million of outflows WTI will experience from the rebalance.  The main reason this is the case is because the volume of brent only increased 8.9% versus the WTI volume increase of 26.9%.  Also, the average contract reference price fell 32.5% from $65.8 to $44.4 for Brent, versus the lesser WTI drop of $59.4 to $42.1 or 29.0%.

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

Note all the sectors will absorb the dollars exiting energy with the biggest inflow of $258 million for every $10 billion tracking the S&P GSCI going to agriculture.

For information on total AUM tracking commodity indices, please view our replay of the S&P Dow Jones 10th Annual Commodities Seminar and specifically watch Keynote Address: Where in Commodities is the Smart Money Flowing?

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

The Source of Uncertainty

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David Blitzer

Managing Director and Chairman of the Index Committee

S&P Dow Jones Indices

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In 2017 politics, not economics will be the major source of market uncertainty.  The world’s major economies moved past the financial crisis and Great Recession: unemployment rates are at more acceptable levels and central banks are discussing the end of quantitative easing. Equity markets in the US and the UK made new all-time highs while those in Europe, Japan and Australia are well above their lows.  Yields on ten-year treasuries are rising in the same countries. Inflation remains low and deflation worries have faded away.

Just when investors thought they could look forward to less complicated times, politics re-appeared with Brexit, oil, the new administration in Washington and elections in France and Germany.  Politics is the focus now.  Many investors follow economic calendars for events like the employment report on the first Friday of each month. A political calendar may be useful as well — a few likely events are cited below. By late this year uncertainty won’t be erased but some direction might be visible.

Shortly after the January 20th presidential inauguration we are likely to see proposals and bills appear on Capitol Hill with details on tax cuts and spending increases.  These will be closely watched but will contain little real information for investors until they are close to being enacted.   Every president since Franklin Roosevelt made promises about the first 100 days – and only Roosevelt in 1932 achieved much in his first 100 days. If either tax cuts or infrastructure spending are enacted before Brexit’s article 50 is invoked, it will show unexpected speed.

Brexit came on the scene last June with the British vote to leave the EU. Recent remarks by British Prime Minister Theresa May suggest a “hard Brexit” with very limited migration allowed between the UK and EU and a need for several new trade agreements.  The first step is to invoke Article 50 to start the clock running on two years of negotiations on new rules of engagement between Britain and Europe. Article 50 is promised by the end of March but few expect everything to be settled in two years. For markets, some clarity may be found when both sides explain what they want. As talks drag on there could be periodic swings in the pound and euro against each other and the dollar.

Elections in 2017 in France and Germany will also be closely watched. In France Election Day is April 23rd with a run-off on May 17th.  One question is whether the populist anti-elite pattern seen in Brexit and Donald Trump’s US victory will carry over to France. Any sign of populist or nationalist gains could reverberate through markets in Europe and the US.  The German election in the fall may be a larger test of populism because Angela Merkel will be running for re-election. Germany’s election must be held between August 27th and October 22nd 2017; a September date is likely.

Politics and oil often mix. The recent agreement among OPEC to reduce output, which boosted oil prices over $50 per barrel, was built on political agreements within OPEC and outside with Russia and other producers. The cuts took effect on January 1st and are planned to last for six months.  With the rig count in the US and Canada already creeping up, the oil markets may look different in June.

Just because politics is the source of uncertainty investors shouldn’t forget the fundamentals of earnings, inflation and growth – they’re what matters in the long run.

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

Dow Jones Industrial Average® 2016 Year in Review

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Jamie Farmer

Chief Commercial Officer

S&P Dow Jones Indices

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The Dow Jones Industrial Average ended 2016 at 19,762.60 – up 2.337.57 points for a 13.42% annual return, the best year since 2013 when the market surged over 26%.

  • Biggest Themes – markets were driven by the crash (and partial recovery) in oil prices, Fed-watching, China, Brexit and questions regarding the US economy. Oh yeah, there was a Presidential Election too – it was so under-reported I almost forgot to mention it.
  • Leader & Laggard – Goldman Sachs (GS) contributed the most to the DJIA’s advance during the year; Nike (NKE) was the biggest detractor.
  • Sector Performance – Financials were the best performing sector during 2016; the Consumer Discretionary sector posted the worst performance.
  • Best Day YTD (In Points & Percent) – January 29th, an otherwise bright spot in a rather tough month.
  • Worst Day YTD (In Points & Percent) – June 24th, when the UK votes for Brexit.
  • New Highs – the DJIA posted 26 new highs in 2016, including two separate streaks of 7 straight records in July and December.

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Download the full report

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

Year in Review: 2016 Asset Class Performance

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Jason Giordano

Director, Fixed Income, Product Management

S&P Dow Jones Indices

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The high-yield corporate bond segment, as measured by the S&P U.S. High Yield Corporate Bond Index, was the top-performing asset class for 2016, posting a total return of 17.2%.  Despite a rather tumultuous first quarter, 2016 finished with a clear “risk-on” sentiment as evidenced by the asset classes that topped the list.

On Feb. 11, 2016, it looked like quite the opposite, as high-yield bonds were down over 4%, and U.S. equities (S&P 500®), REITs (Dow Jones U.S. Select REIT Index), and commodities (S&P GSCI) were down 11%, 12%, and 13%, respectively, to start the year.  Then, as if lifted by the price of oil bouncing off its bottom, higher-risk asset classes all entered positive teritory by the end of April 2016.  The second quarter ended with some increased volatility, as markets reacted to (and then quickly moved on from) the surprise Brexit referendum that was announced on June 24, 2016.  A brief flight to quality increased demand for U.S. Treasuries (S&P U.S. Treasury Bond Index), municipals (S&P Municipal Bond Index), and investment-grade corporates (S&P U.S. Investment Grade Corporate Bond Index), and U.S. equities briefly dipped back into the red.

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Excluding commodities, the third quarter saw relativley low volatility.  Positive economic results and strong earnings from higher beta sectors propelled equities, high-yield corporate bonds, and leveraged loans (S&P/LSTA U.S. Leveraged Loan 100 Index).  The fourth quarter largely hinged on market participant sentiment leading up to and then reacting to the unexpected result of the U.S. presidential election.  Post-election, a focus on potential inflationary conditions and increased interest rates put upward pressure on bond yields.  Market participants ended 2016 favoring higher risk asset classes such as equities (S&P 500), commodities (S&P GSCI), and REITs (Dow Jones U.S. Select REIT Index).

Exhibits 2 and 3 show the total return performance of the major asset classes, taking into account their respective volatility.  In Exhibit 2, the column on the left ranks the major asset classes in terms of total return for 2016.  The column on the right re-ranks the asset classes by risk-adjusted returns, or Sharpe ratio, based on volatility (i.e., daily standard deviation throughout 2016).  The Sharpe ratio is used to compare investment options in a manner that shows total return per unit of risk.  Perhaps most surprisingly, leveraged loans (S&P/LSTA U.S. Leveraged Loan 100 Index) jumped to the top with a Sharpe ratio of 6.4, helped by extremely low volatility for the asset class.  Investment-grade corporate bonds also benefitted from relatively low volatility moving to the top-three performing asset classes on a risk-adjusted basis.  Not surprisingly, commodities (S&P GSCI) experienced the greatest amount of volatility (standard deviation of 23.8%) and fell out of the top-three on a risk-adjusted basis.

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