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Most S&P and Dow Jones Islamic Indices Outperform Conventional Benchmarks in 2017

Energy Just Had Its Worst Start in 19 Years

Green Bonds: Addressing Solvency II Benchmarking Requirements

Confusing Means and Ends

Carbon Pricing Is Essential for Effective Climate-Related Financial Disclosure

Most S&P and Dow Jones Islamic Indices Outperform Conventional Benchmarks in 2017

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Michael Orzano

Senior Director, Global Equity Indices

S&P Dow Jones Indices

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Most S&P and Dow Jones Shariah-compliant benchmarks outperformed their conventional counterparts year-to-date through June 28, 2017 as Financials – which are largely absent from Islamic indices – have lagged the broader market, and Information Technology and Health Care – which tend to be overweight in Islamic Indices – have been the two top performing sectors so far this year.

Global equity markets added to strong Q1 gains as the Dow Jones Islamic Market World and S&P Global BMI Shariah Indices gained 13.6% and 13.3%, respectively for the year.  Each index outperformed the conventional S&P Global Broad Market Index (BMI) by about 2.5%.  In the U.S., the S&P 500 Shariah gained 10.4% for the year, outperforming the S&P 500 by 1.4%.  Regional Dow Jones Islamic Market benchmarks for Asia-Pacific, Europe and Emerging Markets all beat their conventional counterparts by meaningful margins as well.

Asia-Pacific, Europe and Emerging Markets Lead Global Equity Markets Higher

Gains were broad based across global equity markets.  However, Asia-Pacific, Europe and Emerging Markets have led the way as improved economic prospects and investor sentiment along with strengthening currencies contributed to high double-digit U.S. dollar denominated returns.   Despite recently lagging other major regions, U.S. equity markets have remained strong as the S&P 500 recorded several new all-time highs in 2017 and was up 9.0% year-to-date through June 28.

Weak Oil Prices and Political Uncertainty Weigh on MENA Equities

After a strong finish to 2016, MENA equities have significantly lagged global equity markets in 2017 as falling oil prices and political uncertainty arising from the diplomatic rift between several Arab nations and Qatar weighed on the region’s equity markets.  The S&P Pan Arab Composite Shariah eked out a gain of 1.0% year-to-date through June 27, matching the return of the conventional S&P Pan Arab Composite Shariah.  The S&P Qatar BMI sank 13.2% over the same period with most of the losses concentrated following the June 5 flare up of diplomatic tensions.

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

Energy Just Had Its Worst Start in 19 Years

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Jodie Gunzberg

Managing Director, Head of U.S. Equities

S&P Dow Jones Indices

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Commodities just had their worst start in seven years.  The S&P GSCI Total Return lost 10.2% year-to-date (YTD) ending June 30, 2017, logging its worst first half (H1) performance since the first six months of 2010 when it lost 11.2%.

However, it’s not the bloodbath it may seem to be.  Half, or 12 of the 24 commodities in the index, and three of five sectors were positive YTD through June 2017.  The best and worst single performers came from the same sector, agriculture.  Wheat was the winner, gaining 18.3%, while sugar was the biggest loser, down 29.9%, contributing to an overall sector return of -2.2%.  Although in the first half of 2017, the needle fell just short for agriculture, livestock gained 12.5%, industrial metals were up 8.1% and precious metals were solidly positive 6.9%.

On the other hand, the driver of the poor index performance thus far in 2017 stems from the relatively heavy weight in the energy sector.  The S&P GSCI Energy Total Return  lost 18.8% YTD through June 2017, its worst start in a year since 1998 – almost two decades.

Source: S&P Dow Jones Indices LLC, a division of S&P Global.  The launch date of the S&P GSCI Energy Total Return was May 1, 1991.*

Each single commodity inside the energy sector didn’t just lose in the first half of 2017, but lost double digits.  This is only the second time all six energy commodities lost in the first half of a year (2010 was the first time.  Also, in 1990, 1991 and 1997, before Brent crude and gasoil were included in the index, all the singles were negative in H1.)  Moreover, in the first half of 2017, two of the six energy singles lost more than 20%, the mark that typically denotes a bear market.  This is the fourth time since 1984, two or more energy singles were down over 20% in the first half of a year, with other occurrences in 1990, 1997 and 1998.

The negative returns in H1 2017 of the commodities in the energy sector are worth noting individually —  Brent crude -17.4%, (WTI) crude oil -18.8%, gasoil -15.8%, heating oil -16.5%, natural gas -26.4% and unleaded gasoline – 22.3% — since without them, commodities were positive in the first half.  The S&P GSCI Non Energy Total Return gained 4.1% in the first half of 2017, outperforming the S&P GSCI Energy Total Return by 22.9%, the most in a first half in 27 years or since 1990.

Source: S&P Dow Jones Indices LLC, a division of S&P Global.  The launch date of the S&P GSCI Energy was May 1, 1991. The launch date of the S&P GSCI Non Energy was May 1, 1991.*

In two recent notes, the reasons for this split in performance were discussed, with this note focusing on energy and easy to read charts on contango and backwardation.  The term structure is important since it reflects the storage costs that determine returns from rolling.  Negative roll returns measure the costs from excess inventory that have plagued energy investors beginning in Nov 2014.  One potentially positive sign is that unleaded gasoline, the most backwardated commodity of all, gained a roll return of 43 basis points in June that has ended its long contango streak from Dec. 2016.  Another possibly optimistic sign in June from energy is that for the first month since Nov. 2016, the roll yield loss was less for WTI than for Brent.   (WTI) crude oil lost 50 basis points in June versus the roll yield loss of 72 basis points in the month for Brent crude.  This shift in roll return may reflect declining U.S. inventory cost relative to the international market, pointing in the right direction toward the probable key factor in the oil re-balance.

*All information presented prior to the index launch date is back-tested. Back-tested performance is not actual performance, but is hypothetical. The back-test calculations are based on the same methodology that was in effect when the index was officially launched. Past performance is not an indication or guarantee of future results. Please see the Performance Disclosure at http://www.spindices.com/regulatory-affairs-disclaimers/ for more information regarding the inherent limitations associated with back-tested performance.

 

 

 

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

Green Bonds: Addressing Solvency II Benchmarking Requirements

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Dennis Badlyans

Associate Director, Global Research & Design

S&P Dow Jones Indices

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Solvency II is the new region-wide supervisory framework for insurance and reinsurance companies operating in the European Union.  The new regime includes three pillars, calculation of capital reserves, management of risk and governance, and reporting to the national supervisory authority.  Moving to a risk-based approach in calculating solvency capital requirements (SCR) will require reassessment of investment choice.  Risky assets that will require a higher charge may become less appealing vis-à-vis a low risk asset, despite the expectation of better performance.

It falls on insurers to classify assets; certain types are well defined while some types need to be assessed against an extensive list of criteria, including qualitative factors.  In calculating SCR, insurers may follow the standard formula, develop an internal model subject to supervisory approval, or use a combination of the two.  Focusing on the standard formula approach, insurers will determine the level of instantaneous shocks prescribed for each asset to aggregate into a total capital requirement.

Cash-flow risk, issuer/credit risk, and duration risk are among the key factors in determining the prescribed shock schedule.  For example, a government bond issued by an EU member state in an EU member currency has a risk weight of 0%, while a B+ rated, 25-year duration corporate bond will have a risk weight of 66%.  In particular, exposure to member state central government debt, certain multilateral development banks, and certain international organizations, as well as debt guaranteed by member states’ central government, are assigned a risk weight of 0% (article 180, paragraph 2 of Regulation (EU) No 2015/35).

Looking at the types of securities that can potentially qualify for lower capital charges, green bonds stand out as one possible candidate for those requiring 0% capital charge.  Multilateral development banks and international organizations are among the active issuers in the green bond market.  Additionally, sovereign issuers such as Poland and France have initiated issuance in the green bond market.  Hence, an index of qualifying green bond securities could serve the industry as a 0% capital charge benchmark for European insurers and reinsurers.

We can highlight a hypothetical basket of qualifying securities by screening for these specific issuers within the S&P Green Bond Select Index, excluding U.S. municipals.  The screen produces a hypothetical portfolio of 42 green bonds, representing 31.9% of the S&P Green Bond Select Index market value (Exhibit 1).

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

Confusing Means and Ends

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Craig Lazzara

Managing Director and Global Head of Index Investment Strategy

S&P Dow Jones Indices

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This morning’s Wall Street Journal informs us that the growth of exchange-traded funds has “propelled” this year’s surge in equity prices.  “Booming demand for passive investments is making exchange-traded funds an increasingly crucial driver of share prices….Surging demand for ETFs this year has to an unprecedented extent helped fuel the latest leg higher for the eight-year stock-market rally.”

Or has it?  Suppose I edit the sentence quoted immediately above to read “Surging demand for equities this year has to an unprecedented extent helped fuel the latest leg higher for the eight-year stock-market rally.”  I’ve changed only one word, and yet the entire connotation of the sentence is different.  “Surging demand for equities” means only that investors, as a group, want to increase their exposure to the stock market.  In hindsight their decision may or may not prove wise, but it’s hard to make such a choice sound sinister.

ETFs are not a unique asset class.  They are a means by which investors can invest in the assets which have long formed the core of their portfolios.  There are, of course, a number of advantages to the ETF structure – transparency, ease of implementation, access to institutional strategies for the small investor, low cost, tax benefits – and these advantages may go a long way to explaining why an investor might prefer ETFs to traditional mutual funds.  But an ETF, mutual fund, or separate account are simply different ways to hold a given portfolio of assets; as such they are less important to an investor’s ultimate success than the choice of which portfolio to hold.

And for that choice, investors have increasingly realized that their interests are best served by placing passive index vehicles at the core of their portfolios.  Active managers, as a group, have consistently underperformed passive benchmarks, and above-average active performance, when it occurs, tends not to persist.  As the Journal recognizes, these facts have resulted in a continuing migration of assets from active managers to index-linked portfolios.  ETFs are not the cause of this shift, but rather one of the vehicles by which it is taking place.

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

Carbon Pricing Is Essential for Effective Climate-Related Financial Disclosure

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James Richens

Research Editor

Trucost, part of S&P Global

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The Financial Stability Board’s Task Force on Climate-related Financial Disclosures published its final report on June 29, 2017, leaving many companies and market participants considering how best to implement its important recommendations.

The recommendations are groundbreaking because they recognize climate change as a systemic risk to the financial stability of the global economy and present actions that all participants in the investment value chain should take—from asset owners to companies—to mitigate the risks and capitalize on the opportunities.

One of its key recommendations is that organizations should consider the scenario analysis of potential business, the strategic and financial implications of climate change and disclose them in their annual financial filings.  Organizations should assess a range of scenarios that cover reasonable future outcomes, favorable and unfavorable, including the transitional risks associated with commitments made by nearly 200 countries under the Paris Agreement to limit the increase in the global average temperature to 2°C.

One of the main transitional risks is increasing carbon regulation through carbon taxes, emissions trading schemes, or fossil fuel taxes.  Carbon prices have already been implemented in 40 countries and 20 cities and regions.  These regulations could drive up the cost of fossil-fuel-based energy and carbon-intensive raw materials, increasing operating costs and reducing profit margins.  Revenue growth may be constrained for companies that sell energy-intensive products when competitors have low-energy alternatives.  Asset owners and banks are exposed to these risks through their investments and loans to companies in carbon-intensive sectors.

However, organizations face uncertainty over the pace at which carbon regulation will be implemented in different regions—particularly those with global operations.  The solution is to conduct scenario analysis using a range of potential carbon prices.  Exhibit 1 illustrates this at a global level, with forecasts from a threefold increase in regulated carbon prices based on full implementation of the existing Paris Agreement commitments (light blue line) to a sevenfold increase, assuming policies needed to achieve the 2°C goal are implemented (navy line).  A range of other possibilities exists between these extremes, as represented by the yellow lines.

Tools exist to help organizations calculate carbon prices, such as Trucost’s Eboard carbon price calculator, which market participants can use to calculate the at-risk revenue of companies in their investment portfolios and create investment strategies to minimize their exposure to that risk.  Trucost also works with companies to calculate internal carbon prices to quantify the financial implications of carbon regulation on cash flow, operating margins, and profits in different regions, highlighting those most at risk.

The Financial Stability Board says that all organizations should strive to conduct scenario analysis that is robust, comparable, consistent, and transparent.  Carbon pricing helps organizations meet these objectives by providing a powerful diagnostic tool to understand climate-related risks and opportunities in financial terms and explain to market participants how they are preparing for business in a low-carbon world.

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