## Mutual Fund Portfolios: Equal Weight or Cap Weight?

U.S. Head of Index Investment Strategy

S&P Dow Jones Indices

Equal-weighted indices typically outperform their cap-weighted counterparts (although 2017 so far has proven to be an exception to the general rule).  This means that portfolio managers can usually create a performance tailwind by equal weighting rather than cap weighting their holdings.

But do they?  One way to assess this question is by using the Herfindahl-Hirschman Index (HHI).  The HHI is a measure of market concentration, often used in industrial organization studies, that has the great virtue of being easy to compute: simply sum the squares of the market share of each firm competing in a market.  Possible HHI values range from 0 to 10,000.  This measure can be applied to portfolios by summing the squares of each holding’s percentage weights.  For example, the HHI value of a single-stock portfolio is 10,000 (the maximum possible); the HHI value of a 100-stock, equal-weighted portfolio is 100.

We applied the HHI to a handful of mutual fund portfolios in order to assess where their portfolio construction methodologies lay on the spectrum between cap and equal weight.  This is a simple exercise: compute each fund’s actual HHI value, and then compute comparative HHI values by assuming that the fund’s holdings were cap weighted or equal weighted.

We sampled funds with holdings that ranged from less than 70 names (Dodge & Cox) to those with more than 1,000 (Parametric Emerging Markets).  With one exception, the funds’ portfolio weights in our sample were much closer to equal than to cap weighting.

For funds to come close to cap weighting, they must maintain substantial portfolio weights in large-cap names.  For example, if Dodge & Cox’s Microsoft holding were cap weighted, it would amount to 12% of the fund (instead of its actual 3%).  Fidelity Magellan would hold 10% in Apple to be cap weighted, but only holds half that at 5%.  T. Rowe Price should also hold 10% in Apple, but strays even further, with only a 1% portfolio weight.  Parametric Emerging Markets needs a 4.9% weight in Samsung to maintain a cap weight, but only holds 0.7%.  Even Growth Fund of America, which is the closest to cap weighting, has only a 1% weight in Apple (where cap weighting requires a 6% weight).  The fund makes up for it by overweighting other large cap names—for instance, it has a 7% weight in Amazon Inc., while cap weighting only requires a 3% weight.

This is an admittedly small sample, but it confirms our intuition that most active portfolios are closer to equal than cap weighted.  This means that their performance, relative to standard cap-weighted benchmarks, could be even worse than you think.

## ESG in India Today

Former Senior Director, ESG Indices

S&P Dow Jones Indices

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Green infrastructure, especially clean and renewable energy, is at the heart of Indian ESG efforts today. Despite the U.S.’s withdrawal from the Paris Agreement, India stands with its commitments made at Paris. The Indian government’s commitment—in context of the recent ratification of the Paris Agreement—is to reduce emissions by 33% to 35% by 2030 and increase the share of non-fossil-fuel-based power generation capacity to 40% of installed electric power capacity, creating new business and investment opportunities.  Achieving India’s target of adding 175 gigawatts of renewable energy capacity by 2022 will require an investment of USD 200 billion.  Assuming a debt-to-equity ratio of 3:1, the sector will require close to USD 150 billion in debt.  Green bonds have started playing a role in financing this capacity and are expected to play a significant role in funding future expansions in renewable energy capacity.  The development of green bonds in India is in its beginning stages and, according to the previous reports, four banks have started implementing green bonds: Yes bank, EXIM bank, IDBI bank, and Axis bank.  Despite this, India has become the seventh largest market for green bonds worldwide, with around USD 3 billion of issuance as of April 2017.

The environment for enabling sustainable investment in Indian-listed equities is currently weak.  Despite some notable exceptions from companies such as Trucost, ESG research coverage is still relatively limited.  Numerous organizations such as The Energy and Resources Institute, the Confederation of Indian Industry, the UN Global Compact, and the International Finance Corporation are active in promoting corporate responsibility and sustainability reporting.  ESG transparency and disclosure by Indian companies in the form of corporate sustainability reports and responses to the Carbon Disclosure Project are slowly improving, but from a low starting point.

However, there is relatively strong and growing interest in ESG risks and opportunities among India’s foreign institutional investors (FIIs), such as large pension funds and asset managers.  Many of these stakeholders are signatories of the UN Principles for Responsible Investment, which has also shown interest in working in India.  Additionally, the National Stock Exchange of India and Bombay Stock Exchange (BSE) have committed to take some leadership in raising ESG awareness among Indian companies and domestic market participants and to brokering a dialogue about these issues between the business community and FIIs.

BSE, being a responsible stock exchange, is taking various initiatives in the domain of sustainability and corporate social responsibility.  BSE has launched theme-based indices like the S&P BSE Carbonex and S&P BSE Greenex and is participating in the sustainable stock exchanges initiative.  BSE has also signed a Memorandum of Understanding with the Ministry of Corporate Affairs to launch a corporate social responsibility index.

## China’s Green Bond Markets

Former Senior Director, ESG Indices

S&P Dow Jones Indices

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China has emerged as a global leader in green finance, especially green bonds, and from 2014 to 2016, it was the fastest-growing market in the region for sustainable investing.  The total amount of green-labeled bond issuances amounted to USD 93.4 billion at the end of 2016 and reflected strong China-based issuances (40% of labeled green bond issuance in 2016 was from China) and momentum from the Paris Agreement.

According to the Climate Change Initiative’s estimate, the labeled green bond issuances that are aligned with the Climate Bonds Initiative (CBI) definition could reach up to USD 150 billion in 2017 (see Exhibit 2).  The total issuances year-to-date reflect China’s position as a leader.

S&P Dow Jones Indices has also been part of the green bond development.  We were one of the first to market when we launched the S&P Green Bond Index in 2014 to encourage market growth and momentum.  In February 2017, S&P DJI broadened its green bond effort and launched the S&P Green Bond Select Index.  The index forms the basis for one of the world’s first green bond ETFs.

## Bubbles and Housing

Former Managing Director and Chairman of the Index Committee

S&P Dow Jones Indices

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Home prices nationally are rising two to three times faster than inflation. They are up 5.5% from a year ago with some cities rising at double-digit rates. Looking at the chart of the S&P Corelogic Case-Shiller Home Price Indices, many are wondering if we’re in another housing bubble.

While prices are rising, the following charts do not point to any bubble.  The next charts cover sales and the visible supply of existing single family homes. Both show a sharp peak immediately before and during the financial crisis followed by a drop.  Home sales have recovered to an annual rate between four and five million units despite stable visible supply of about four months. Condominium sales are roughly flat.

New home supply and sales appear weaker than existing homes.  The supply of new homes is measured by homes on the market, not months-supply and shows that supply remains low. Annual sales are close to the pre-bubble range but far below anything that the peak in 2005.  A similar pattern is seen in housing starts which measure construction activity.

The next S&P Corelogic Case-Shiller release is Tuesday July 25th.

## Asian Asset Owners Are Leapfrogging Into ESG

Former Senior Director, ESG Indices

S&P Dow Jones Indices

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Sustainable investing has become particularly popular in Europe, across many countries.  In the Asia Pacific region, certain countries such as Japan and Australia have shown stronger interest in ESG thanks to asset owner demand, availability of ESG data, and regulatory pressures.  In the last couple of years, we have seen some of Japan’s largest institutional investors, including the Government Pension Investment Fund, which is the biggest pension fund in the world, incorporating ESG into their investment practices.  This has had a major trickle-down effect on the investment value chain, from asset managers to providers of data.

According to a new report launched in May 2017 by BNP Paribas, asset owners and asset managers in the Asia Pacific region have leapt ahead of their European and North American counterparts when it comes to incorporating ESG-related strategies into their investing.  The report, “Great Expectations: ESG – what’s next for asset owners and managers,” found that “84% of the Asia Pacific-based institutional investors surveyed currently incorporate ESG into their investment decision making, compared with 82% in Europe, and only 70% for North America.  And while a fifth of APAC institutional investors currently market a majority of their funds as ESG-compliant, more than 60% expect to do so within two years, highlighting the world’s fastest-growing region is also moving fast in the direction of sustainability.  At present, the largest markets for sustainable investing in Asia, excluding Japan, are Malaysia (30%), Hong Kong (26%), South Korea (14%) and China (14%).”

In terms of strategy, green bonds, sustainable bonds, thematic funds, and investing based on ESG profiles are most popular, although there are some regional differences.