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Tips and Tricks in Reading the Persistence Scorecard

Mightier than Le Pen

Inflation and the Fed

Asian Fixed Income: The Birth of Bond Connect

Embracing the globalization of Chinese equities

Tips and Tricks in Reading the Persistence Scorecard

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Ryan Poirier

Former Senior Analyst, Global Research & Design

S&P Dow Jones Indices

Much has been written about the persistence of manager performance.  The S&P Persistence Scorecard attempts to track the status of top quartile and top half managers over specified subsequent periods.  Over the years, we have received a fair amount of inquiries from our readers regarding the computation, methodology, and interpretation of results.  This blog attempts to address some of the recurring questions and explore some unique features of the scorecard.

The first table in the scorecard shows the headline “performance persistence” figures.  The table uses non-overlapping, one-year periods and is reported over consecutive three- and five-year periods, showing data for the top quartile and top half.  During each one-year period, all of the funds are ranked by the trailing one-year return.  They are then labeled as either being “top quartile/half” or “not included in top.”  The base year, against which all subsequent years are calculated, comprises the funds that we labeled as being in the top quartile over the earliest one-year period.

Exhibit 1 shows this number to be 568 for All Domestic Funds.  Reading the table left to right, we see that 568 * 34.86 / 100 = 198 funds were in both the top quartile for the base year and the subsequent year.  Furthermore, we report that 568 * 1.94 / 100 = 11 funds were in the top quartile in all three one-year periods.

Exhibit 2 shows the same performance persistence over five consecutive periods.  It is important to illustrate this longer time horizon for two reasons.  First, it is generally harder than random chance to remain in the top quartile the further out in time we study.  Second, the most recent results display a particular intricacy; namely, as of March 2017, two funds persisted in All Domestic Funds while no funds accomplished such a feat in the sub asset level categories.  The question then arises: shouldn’t the number of funds on the asset class level at the end of the period aggregate to the All Domestic Funds category?  The answer is no for reasons we will outline below.

The only additive part of the performance persistence is that the sub asset class category counts should add up to the All Domestic Fund category for the base year.  All subsequent years are subject to an interaction effect that makes them not directly comparable.  For example, suppose that all of the unique large-cap funds return 20%-30% each year.  Next, suppose that all of the unique mid-, small-, and multi-cap funds return 0%-5% each year.  Within the large-cap category, it could be the case that no single fund is in the top quartile each consecutive year (displayed in Exhibit 2 as 0% as of March 2017).

A similar result is seen for the remaining asset class categories.  Now, when we combine the universes to examine All Domestic, there will be 100% persistence.  This is because in our simple example, all of the large-cap funds have a return strictly greater than the rest of the universe.  This implies that the top quartile will be approximately the large-cap universe year after year, thus leading to persistence even though the individual categories had none.

The final table format is a transition matrix.  This tracks the movement of funds between quartile/half buckets through time.  From the latest results, as shown in Exhibit 3, we see that of the 528 funds that were in the top quartile, only 31.82% of them managed to repeat that performance over the subsequent non-overlapping period.  Similarly, 21.02% of the bottom bucket disappeared and 8.14% changed their mandate.

With this blog, we attempt to lay out the key steps in interpreting the scorecard so that the results can lead to meaningful educational conversations about manager performance.  These charts, along with the full S&P Persistence Scorecard display the difficulty that fund managers face in trying to repeat their success consistently.

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

Mightier than Le Pen

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Hamish Preston

Associate Director, U.S. Equity Indices

S&P Dow Jones Indices

We publish a series of dashboards at the end of each month to summarize market performance in a number of regions. These dashboards include monthly reports on Risk and Volatility, as well as Factor Dashboards for the U.S. and for Europe on a quarterly basis. With June behind us, a half-yearly summary is in order. Highlighted below are two key themes and trends that have emerged in Europe during the first two quarters of 2017.

The French election caused concern, but the Centrist was mightier than Le Pen.

There were significant elections in Europe during the past six months. Those in the Netherlands and (especially) in France were seen as barometers for Euroscepticism on the continent. They also allowed investors to see whether there would be a continuation of the trend towards economic nationalism and populism that has been observed in various countries globally.

Following the surprise results in several votes in 2016, many investors had come to treat polling data with some suspicion. The possibility of ‘Frexit’ in the event of a victory for Marine Le Pen’s National Front heightened the tension. This nervousness over the outcome of the elections and focus on political risk can be observed in the implied volatility of the currency markets. Taking the average of three such measures – the CBOE/CME FX Yen Volatility IndexSM, the CBOE/CME FX British Pound Volatility IndexSM, and the CBOE EuroCurrency Volatility Index – it is clear that investors’ volatility expectations for the three currency markets have trended downwards over the past year. Nevertheless, there was an increase in average volatility expectations for the three currencies leading up to the French election and a fall once the outcome was observed. We could also observe this pattern around the time of the U.K. Brexit referendum and the U.S. general election.

Brexit weighed on equity market performance

After months of speculation about when the U.K. would formally notify the European Union of its intention to leave, Prime Minister Theresa May announced that the two year negotiation period would commence at the end of March (point A in the chart below). Rather than turning attention to the negotiation immediately, however, the Prime Minister’s decision to call a snap election (point B in the chart) propelled U.K. politics into the limelight once again.

Expectations of an increased majority for the incumbent Conservative Party, which was seen as making a “soft” Brexit more likely, initially helped sterling appreciate against the euro. The impact of the currency movement was evident from the strong performance of the S&P United Kingdom Index (in pounds sterling) in May compared to the same index denominated in euros. The subsequent tightening of the polls (point C) and the realization that no political party had secured a Parliamentary majority saw a complete reversal in this trend.

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

Inflation and the Fed

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David Blitzer

Former Managing Director and Chairman of the Index Committee

S&P Dow Jones Indices

Despite today’s very low inflation the Fed keeps raising interest rates and is now discussing when to shrink its balance sheet to further tighten monetary policy.  The Fed’s own inflation forecast anticipates continued low inflation at 1.6% in 2017 creeping up to 2% in 2018 and 2019 and not seeing any increase later on. Moreover, consumers and the public have similar expectations for low inflation now and in the future. So why is the central bank pushing interest rates higher?

The principal reason is the belief that a low and falling unemployment rate is a reliable signal of future inflation.  This is part of the received wisdom of economic policy which has some basis in the data. It originated with work done by a New Zealand economist, A. W. Phillips, in 1958 comparing unemployment and changes in wages in Great Britain from 1861 to 1957.  Phillips found a consistent relation that showed lower unemployment rates were associated with higher rates of wage inflation.  While the original finding was empirical – based on the data rather than economic theory – the idea soon became the basis for various theories of what causes inflation and how economic policy could lower either inflation or unemployment.

Current data on the U.S. economy since 2000 reveals similar patterns. The first chart shows the unemployment rate and the inflation rate (measured as the year-over-year change in the Core Personal Consumption Expenditures deflator) from January 2000 to May 2017.  As shown, when unemployment rose in 2008, inflation fell, suggesting an inverse relation.  The second figure is the Phillips curve of inflation and unemployment. It plots the unemployment rate on the horizontal axis and the inflation rate on the vertical axis. The regression line indicates that a one percentage point increase in unemployment is associated with a one-tenth of one percentage point decline in inflation.

The Phillips curve doesn’t prove that falling unemployment causes higher inflation. However the idea of a trade-off between inflation and unemployment is embedded in a lot of economic thought. Economists who remember the high inflation of the 1970s and the pain of the 1980 and 1981-2 recessions when unemployment surged and inflation collapsed pay attention to the Phillips curve. The experience of the last 12 months when both inflation and unemployment fell together isn’t enough to erase the Phillips curve.

Based on a combination of experience, data and economic theory, the Fed believes that continued declines in unemployment point to higher inflation rates. At some point the unemployment rate will hit bottom, inflation will be driven higher and a series of rapid increases in interest rates will be necessary. The result of that move could be a recession.

A related argument for gradual increases in interest rates is to prepare for the next recession: Were the economy to contract and the unemployment rate to rise, the Fed would want to lower interest rates. With the fed funds rate at 1.0%-1.25% and ten year treasuries trading at 2.4%, there isn’t much room to cut.  If the Fed slowly pushes interest rates back to more normal levels with the Fed Funds rate at 3%, its ability to stimulate the economy during a recession would be improved.

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

Asian Fixed Income: The Birth of Bond Connect

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Michele Leung

Former Director, Fixed Income Indices

S&P Dow Jones Indices

As a follow up to the previous article, Bond Connect officially launched on July 3, 2017. Bond Connect allows international market participants to trade China’s interbank bonds through the Hong Kong Stock Exchange.  It marked a milestone in China to further open up its capital market, following the China Interbank Bond Market (CIBM) announcement last year. Let’s take a closer look at the recent developments of China onshore bond market.

Similar to other existing channels, like RQFII and CIBM, Bond Connect allows market participants to access China’s onshore bond market, yet through the trade custody and settlement infrastructure connect features, Bond Connect is more cost and time effective for some market participants. As expressed by Bond Connect Company Ltd*, it significantly reduces the account opening time to three working days and improves the price discovery with electronic trading.

According to Mr. Pan*, Deputy Governor from People’s Bank of China, a total of 479 financial institutions invested in the China bond market with over RMB 800 billion under several schemes. The participation of overseas market participants is still low, around 3.9% in government bonds and 1.2% in overall bond markets.  It is unparalleled to the size of the China bond market, which was RMB 53 trillion as tracked by the S&P China Bond Index, hence there is further room for internationalization.

In terms of market performance, the total return of the S&P China Bond Index fell -0.49% year-to-date (YTD), while its yield-to-maturity tightened 23 bps to 4.31% during the same period, data as of July 3, 2017.  The index currently tracks the performance of 9,650 government and corporate bonds from China.  The S&P China Government Bond Index represents over 66% of the overall exposure, with a market value of RMB 35 trillion.

The S&P China Corporate Bond Index has expanded rapidly in the past 10 years, as the market value tracked by the index was RMB 18 trillion, which has increased 34-fold since the index’s first value date on Dec. 29, 2006, and the yield-to-maturity stood at 5.04% with a modified duration of 2.44 (see Exhibit 2 for the yield comparison).

On the back of the growth story, attractive yields, and diversification, the allocations in China’s onshore bonds are poised to rise in the coming years, particularly with the new accesses through Bond Connect and CIBM.

Exhibit 1: Market Value of the S&P China Corporate Bond Index and S&P China Government Bond Index

Exhibit 2: Yield-to-Maturity of the S&P China Corporate Bond Index and S&P China Government Bond Index

*Source: Bond Connect Investor Forum on July 3, 2017.

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

Embracing the globalization of Chinese equities

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Vania Pang

Capital Markets and Investment Solutions, Index and Quantitative Investment

ICBC Credit Suisse Asset Management (International) Company Limited

For being the second largest capital market and the second largest economy in the world, China is underrepresented in most of the international benchmarks, which is unparalleled with its significance to the world economy. With increased access to the Chinese domestic equities market, one of the largest index compilers received broad support from international investors with whom they consulted and recently announced it would include China A-shares into its benchmark indexes.

  1. Liberalization of capital markets fostering globalization of China assets

The impact of the inclusion in the initial stage is expected to be modest, due to the limited inclusion factor. Nevertheless, the decision shows that the China A market has gained recognition from international investors and cannot be neglected. The globalization of Chinese securities is inevitable and in progress. The opening up of China’s capital market has been accelerated in the past few years, as evidenced by the launch of QFII, RQFII and Stock Connect programs. CSRC Vice Chairman Mr. Fang Xinghai mentioned that they would consider increasing the Connect daily quota and reforming the QFII quota system for better foreign access[1].

Once the capital market of China is liberalized, it is believed that Chinese equities will become more prominent in the portfolios of global assets allocators in order to reflect the importance and influence of its economy and financial markets. With the expectation of China’s gradual increase in weighting in international benchmarks, global investors are called to pre-position themselves for the irreversible trend of China assets globalization. A broad-based index and related investment products which can better represent the Chinese economy would be an ideal building block of global and/or regional equity portfolios.

  1. S&P China 500 – in response to increasing market demand for a “Total China” index

Against the backdrop of broadened capital flows between domestic China and international markets, the demand for benchmarks that integrate the China onshore and offshore listings has been increasing. In response to market demand, the S&P China 500 was launched to offer more complete China coverage by including both onshore and offshore Chinese equities.

The S&P China 500  covers the 500 largest and most liquid Chinese companies, regardless of their listing venue, including the entire universe of Chinese equities, such as A, B, H, Red Chip, P Chip and Chinese securities listed in the U.S. or any other overseas exchanges.

Compared to other major China indices, the S&P China 500 offers a more diversified sector exposure (Figure 1). It is much less concentrated in financials (23%) compared to FTSE A50 (64%), CSI 300 (35%), MSCI China (25%) and HSCEI (72%) as of May 31, 2017. More weight is distributed to new economy sectors, such as I.T. (19%) and consumer discretionary (13%).

Benefiting from its diversification in markets and sectors exposure, the S&P China 500 has demonstrated better risk-adjusted returns (Figure 2). During the period from Dec. 31, 2008, to May 31, 2017, the S&P China 500 generated an annualized return of 10.9% and Sharpe ratio of 0.48; both are the highest among the major China indices.

The S&P China 500 offers more comprehensive market coverage while approximating the sector composition of the broader Chinese equity market, and this makes it a better proxy for the Chinese economy.

[1] Source: Ming Pao, 22 June, 2017.

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