Indexology^® Blog

Volatility has been generally subdued so far this year.  In the latest rebalance, the S&P 500^® Low Volatility Index’s most significant sector shift was to Financials (adding 5% to bring the sector to 21% of the index).  Allocation in the remaining sectors did not deviate too far from the last rebalance. Technology’s weight, which increased significantly after May 2017’s rebalance, declined 1% but is still more than one-tenth of the index.

The methodology for the S&P 500 Low Volatility Index screens for constituents at the stock level, but using S&P 500 sectors as a proxy is often helpful in gaining a better understanding.  The trend of declining volatility persisted in all but the Telecom sector (see chart below).  Not surprisingly, Financials was among the sectors that declined the most in volatility.

The U.S. dollar-denominated, investment-grade sukuk market that the Dow Jones Sukuk Total Return Index (ex-Reinvestment) seeks to track has continued to expand.  As of Aug. 10, 2017, the Dow Jones Sukuk Total Return Index (ex-Reinvestment) tracked 73 sukuk with a market value of USD 74 billion, which represented a growth of 20% YTD.  A total of 11 sukuk with a total outstanding par of USD 19 billion were added to the index so far this year, which surpassed the USD 16.75 billion of new additions in 2016.

As tracked by the index, new sukuk issuances came from countries like Saudi Arabia, Indonesia, Oman, and Hong Kong. Saudi Arabia debuted its first U.S. dollar-denominated sukuk and attracted strong investor demand; it raised USD 9 billion in sukuk, equally split into 5- and 10-year tranches.  Other returning issuers like Indonesia and Oman raised USD 3 billion and USD 2 billion, respectively.  Hong Kong also came back to the market and launched a 10-year sukuk, which extended the yield curve from its two previous five-year sukuk.

The longer-maturity sukuk continued to outperform; the Dow Jones Sukuk 7-10 Year Total Return Index jumped 6.31% YTD as of Aug. 10, 2017. This trend has been consistent in the past few years (see Exhibit 1).  The Dow Jones Sukuk Total Return Index (ex-Reinvestment) increased 3.78% YTD, while the Dow Jones Sukuk Higher Quality Investment Grade Select Total Return Index gained 3.50% YTD.

Exhibit 1: Total Return Performance of the Dow Jones Sukuk Maturities-Based Subindices

Conventional wisdom tells us to maximize our contributions to a 401(k) account and to grow the balance as much as possible for retirement.

However, we may not have considered the decumulation side of retirement income.  If one waits till reaching the age of 70 ½, when the 401(k) balance is larger, he/she may face a large annual tax bill waiting, as the law requires withdrawals of a certain minimum amount from the balance.  The withdrawals are treated as ordinary income and as a result may end up in a higher marginal income tax bracket.

There are two age-related rules governing the withdrawals from one’s 401(k) plan and the traditional Investment Retirement Account (IRA).  The first one is the rule of 59 ½, which stipulates that, generally, for participants under the age of 59 ½, they must pay a 10% additional tax on the distribution from the account.  After reaching the age of 59 ½, participants can receive distributions without having to pay the 10% additional tax.

The second age-related rule is the rule of required minimum distributions (RMDs).  Individuals are required to begin lifetime RMDs from their IRAs no later than April 1 of the year after they reach the age of 70 ½.  This is in contrast with RMDs from employer-sponsored plans, which, in most cases, may be postponed until after the employee retires or reaches age 70 ½, whichever happens last.  One may have to pay a 50% excise tax on the amount not distributed as required.

Thus, there is an 11-year window during which withdrawals from such retirement savings accounts can be made, but are not required.  Against that background, an optimal strategy may be to smooth out one’s retirement income from all sources in such a way that the marginal income tax rate is at the lowest possible level.  In the event that one wants to delay receiving social security benefits until age 70 (in order to max out the social security benefits), tapping into a 401(k) or IRA to provide interim stopgap income could be considered.

RMD is based on life expectancy, and at 70 it is 3.65%.[1]  For the full table and all the details related to RMD, please consult IRS Publication 590-B.[2]

In 2014, the U.S. Treasury and the IRS amended the RMD regulations in such a way that the part of the account balance that is subject to the RMD can be allowed to purchase a qualifying longevity annuity contract (QLAC) , as documented on page 10 of our paper “Rethinking Longevity Risk: A Framework to Address the Tail End.”  Thus, by purchasing a QLAC which begins to pay the amount contracted no later than at age 85, one can defer the tax burden on one’s retirement assets for up to 15 years and have a guaranteed lifetime income starting at or before age 85.

[1] For an RMD calculator, see http://www.kiplinger.com/tool/retirement/T032-S000-minimum-ira-distribution-calculator-what-is-my-min/index.php

[2] See https://www.irs.gov/pub/irs-pdf/p590b.pdf

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/

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.