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Whether the Market Is Overvalued or Not, It Can Pay to Rebalance

Exploring Dividends in Peru

Energy Posts Its Best July Since 2004

Mutual Fund Portfolios: Equal Weight or Cap Weight?

ESG in India Today

Whether the Market Is Overvalued or Not, It Can Pay to Rebalance

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Philip Murphy

Managing Director, Global Head of Index Governance

S&P Dow Jones Indices

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Current valuations of U.S. stocks inevitably lead to debate over their prospects for future returns, earnings sustainability, and whether we are in the midst of a stock market bubble.  Some measures indicate the market is richly valued by historical standards, but no one knows what the future holds.  However, one thing is clear—the potential value of rebalancing defined contribution retirement accounts.  As discussed in a recent PlanSponsor article by John Manganaro,[1] record 401(k) balances and equity performance could be skewing retirement accounts to higher equities allocations.  Plan participants can take advantage of automatic rebalancing if their plans offer it, or rebalance themselves if they have not done so recently.  Of course, rebalancing may result in transaction costs, so it should be assessed in light of the costs and benefits.

Retirement accounts that have not been rebalanced in a significant period of time would probably be good candidates for review.  For example, if never rebalanced, a portfolio that allocated 70% to the S&P 500 and 30% to the S&P U.S. Aggregate Bond Index as of June 2012 would have over 80% of its weight in stocks as of the end of June 2017.

Suppose your target allocation in 2012 was 70% stocks and 30% bonds.  Your account would be overweight in equities by over 10% if your target were still 70%.  But if you are approaching retirement, perhaps your new target is a lower stock allocation, such as 60%.  That would mean your account is more than 20% overweight in stocks.  That could represent a lot of unintended risk if you don’t take the time to rebalance.

Many of the challenges in achieving investing success come down to discipline.  Avoiding overreactions when markets soar or dive, diligently saving, being aware of costs, diversifying within and across asset classes, and sticking to a reasonable investment policy that includes periodic rebalancing will go a long way toward reaching success.  With automatic rebalancing and the prevalence of target date funds in 401(k) plans, many plan participants can automate these steps.  But for those who do not or cannot, it is wise to monitor investment allocations and rebalance when actual allocations differ substantially from one’s investment policy.

[1] http://www.plansponsor.com/Record-Balances-May-Skew-DC-Accounts-Towards-Equity/

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

Exploring Dividends in Peru

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Manuel González

Director, Client Coverage, Latin America

S&P Dow Jones Indices

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What does it mean when we talk about dividends?  When a company pays dividends, it shows that it is generating enough flow and profits, and that it seeks to generate an additional flow to its shareholders.

In May 2016, S&P DJI published a research paper entitled “Exploring Liquidity and Dividends in Peru.”[1]  This report identified that Peruvian companies have historically paid dividends: “Over the 10-year period ending Dec. 31, 2015, an average of approximately 70% of the companies in the Peruvian equity market distributed cash dividends annually.”

One way to find out about the possible impact of dividend payments on a portfolio’s performance is through the indices.  The performance of an index is calculated using the price movement of its components (price return), and the addition of dividends (total return).  The components and their weights are the same but the results are different.  In the case of the S&P/BVL Peru Select Index, for example, its YTD performance in Peruvian nuevos soles showed a return of 4.67%, while if we take the same index and incorporate the dividend payments, we see a return of 6.74% YTD (as of July 8, 2017).

On the other hand, there are indices that are created in order to identify companies that pay dividends consistently over a period of time.  In Peru, for example, the Lima Stock Exchange (BVL) and S&P DJI recently launched the S&P/BVL Peru Dividend Index on May 25, 2017.  The construction of this index started with the S&P/BVL Peru Select Index universe, but it only includes those companies that made dividend payments consistently over the past 12 months as of the rebalancing date, and the weighting of the components was by its dividend rate.[2]  The performance of the indices differs; for example, the S&P/BVL Peru Dividend Index registered a total YTD return performance of 17.44%, while the S&P/BVL Peru Select Index was 6.74% (as of July 8, 2017 in nuevos soles terms).

These results, wherein the performance of the dividend index is higher than the broad or benchmark index, are consistent across all markets.  Since 1956, dividends have accounted for about one-third of the S&P 500® total return.  As a final thought, “dividend indices have historically offered attractive yields and total returns, allowing market participants to participate in up markets while potentially achieving protection in down markets.”[3]

[1]   Exploring Liquidity and Dividends in Peru

[2]   The dividend rate is calculated based on the dividend paid per share during the preceding twelve months, divided by its price at the rebalancing date

[3]   Selecting a Dividend Index? Three Factors Worth Considering.

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

Energy Posts Its Best July Since 2004

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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 Energy Total Return gained 8.1% in July, the most for a July in 13 years, led by petroleum that was up 9.2%.  Finally the fundamentals may be showing the oil market is starting to rebalance with the rest of the commodities.   The S&P GSCI Total Return had its best month this year, gaining 4.6%. lessening its year-to-date loss to -6.1%, while the Dow Jones Commodity Index gained 3.5% for a year-to-date loss of -2.1%.

Three of five sectors were positive that included both industrial metals and precious metals along with best performer, energy.  Also two-thirds or 16 of 24 commodities were positive for the month, the most since Sep. 2016, led by unleaded gasoline that was up 12.4%, its best month since Apr. 2015 and hottest July since 2005.  Other top performers were heating oil, gasoil and coffee, with total returns up 12.2%, 11.8% and 10.9%, respectively.  The biggest losing single was the S&P GSCI Kansas Wheat with a total return of -10.3% for July, its worst month in 2 years since July 2015.

Source: S&P Dow Jones Indices

Given Brent and WTI crude oil together have just over 40% weight in the S&P GSCI, they contributed heavily, 3.4%, to the 4.6% gain in July.  Although according to the International Energy Agency (IEA,) OPEC compliance fell to just 78% in June, they are hoping to improve compliance by capping Nigerian production.  However, the cuts may be already be impacting the market as about 1 million barrels per day have been removed in addition to further cuts from non-OPEC countries.  Also, a key factor in the oil price rebound is U.S. production may be starting to slow as companies reach drilling capacity and fear the risk of another drop in oil prices.  This may happen just as Saudi Arabia cuts oil exports to the U.S., potentially accelerating the inventory reduction.

One possibly bullish sign is the S&P GSCI Enhanced Crude Oil signaled it is time to hold the near contract rather than the later dated one.  Today the enhanced index will start its five day rolling period to roll out of the Dec. 2018 contract and into the Oct. 2017 contract.  This is the first time the index will hold the near contract since Nov 2014.  The rule in the methodology that determines the contract says, “it will hold the near contract if the contango is not more than 0.50%.”

In July, the roll return, as measured by the excess return less the spot return, was -0.45% for crude oil.  The negative roll return still reflects contango, a losing condition where near contracts are cheaper than later dated ones, mainly resulting from excess inventories with high storage costs. While the contango is still present, it is the least since Dec 2014, when the crude oil roll return measured -0.23%.  The S&P GSCI Crude Oil Spot Return year-to date through July was -6.6%, but the total rolling loss (year-to-date through July) subtracted an additional 5.6% from index positions in the most liquid nearby contracts, dropping the S&P GSCI Crude Oil Excess Return to -12.2% in 2017.   This is far less than the negative impact in the first seven months of 2015 and 2016 when the roll costs were -12.7% and -20.8%.

Source: S&P Dow Jones Indices

 

 

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

Mutual Fund Portfolios: Equal Weight or Cap Weight?

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Anu Ganti

Senior Director, Index Investment Strategy

S&P Dow Jones Indices

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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.

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

ESG in India Today

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Tianyin Cheng

Senior Director, Strategy and Volatility 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.

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