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Impact of Term Structure on VIX® Futures Correlation with Bond Sectors

SPIVA Europe Mid-Year 2017 Scorecard: Active Versus Passive – Consistency Is Key

Market Agnosticism

DJSI Push Companies to Achieve the SDGs

Correlation Analysis of VIX® and High Yield and Emerging Market Bonds

Impact of Term Structure on VIX® Futures Correlation with Bond Sectors

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Berlinda Liu

Former Director, Multi-Asset Indices

S&P Dow Jones Indices

Recently my colleague wrote about the correlation between VIX (spot and futures) and two credit sectors (high-yield and emerging market bonds).  The blog shows that VIX futures exhibit stronger negative correlation than VIX spot and that this stronger negative correlation of bonds to VIX futures than to VIX spot comes mostly from down markets.  In this blog, we further explore the asymmetric correlation between VIX futures and those two credit sectors.

Not limited to VIX, futures markets in general do not tend to move with the spot in the same magnitude.  On rare occasions, the two may even move in opposite directions.  When trading futures, market participants need to take into account an additional cost, the so-called “cost of carry,” of maintaining or holding a position in the market.  The cost of carry can appear in different ways, including interest on bonds, storage cost of commodities, and, in the VIX futures market, roll cost of futures contracts.

The stronger negative correlation of credit bonds to VIX futures than to VIX spot could be explained largely by the change in the futures curve when VIX spikes.  In other words, when the high-yield and emerging bond market is in distress, VIX goes up and the VIX futures curve flips from contango to backwardation, which causes VIX futures to move even further in the opposite direction of the high-yield and emerging market bonds.

To verify this conjecture, we calculated the monthly average roll cost of the S&P 500® VIX Short-Term Futures Index as the monthly average slope between the first-month futures and the second-month futures.  A positive roll cost indicates cost while a negative roll cost indicates yield.

Exhibits 1a and 1b show the monthly roll cost of the S&P 500 VIX Short-Term Futures Index in the months when high-yield and emerging market bonds posted losses between February 2006 and April 2007.  When high-yield bonds were down, the correlation between their monthly return and the monthly roll cost of VIX futures was 75%, indicating that the VIX futures curve was more likely to be in backwardation.  When emerging market bonds were down, the correlation between their monthly return and the monthly roll cost of VIX futures was 56%, also an indicator of backwardation in the VIX futures curve.

Exhibits 1a and 1b also show that larger loss in high-yield and emerging market bonds was usually associated with higher roll yield from VIX futures backwardation.  This is further illustrated in Exhibits 2a and 2b; in the months that high-yield and emerging market bonds posted a loss of more than 3%, VIX futures ten   ded to rise, sometimes even more than the VIX spot, due to the backwardation in the VIX futures curve (or, in other worlds, the yield from the roll of a long VIX futures position).

From the above observation, we conclude that backwardation in the futures term structure explains the stronger correlation between VIX futures and these two bond sectors in down markets.

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

SPIVA Europe Mid-Year 2017 Scorecard: Active Versus Passive – Consistency Is Key

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Andrew Innes

Head of Global Research & Design

S&P Dow Jones Indices

It’s that time of the year and the highly anticipated SPIVA Europe Mid-Year 2017 Scorecard is out.  European active fund managers are no doubt apprehensively looking to see how their industry is competing with the performance of their respective S&P DJI benchmark indices.

At first glance, active proponents may breathe a sigh of relief for doing better than usual over the past year.  After all, when comparing the 50.9% of actively managed European equity funds that underperformed their passive benchmark from mid-2016 to mid-2017, they may argue it is considerably better than the equivalent figure of 80.4% reported in the SPIVA Europe Year-End 2016 Scorecard.  Active managers in several countries, most notably the UK, France, Denmark, and Switzerland, may go as far as celebrating that more than half of funds investing in equities in the region outperformed over the past year.

The reality is that active funds investing in pan-European equities collectively failed to beat the benchmark over the past year.  The S&P Europe 350 showed an impressive one-year return of 18.6%, while euro-denominated active funds investing in pan-European equities underperformed, with an average asset-weighted performance of 17.6%.  Even more interesting is that the annual return of the average stock within the benchmark was 23.3%, represented by the S&P Europe 350 Equal Weight Index.  This means that the mean return of a large group of randomly weighted portfolios would have likely outperformed the S&P Europe 350 by a significant margin.

But to avoid any shortsightedness in the analysis of the latest SPIVA Europe Scorecard, let’s step back to observe the consistency in the results from active equity fund managers.  So instead of just looking at the number of funds in Europe that underperformed over the past year, we took a look over a longer time frame.  In doing so, looking over the past 10 years, we found the percentage of actively managed funds across each category in the SPIVA Europe Scorecard that underperformed the benchmark ranged from 72-98%.  Therefore, finding funds that will outperform their benchmarks over the long-term appears to be the real skill.

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

Market Agnosticism

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Craig Lazzara

Former Managing Director, Index Investment Strategy

S&P Dow Jones Indices

This weekend’s Financial Times brought John Authers’ provocative article on the frequency of financial crises.  Along the way, John gives us some excellent advice: “We should all work on the assumption that we do not know what will happen next.”

John’s view of crisis prediction applies equally to the quotidian work of investment management.  Since we don’t know which styles or managers will be in favor next quarter or next year, how should investors manage their agnosticism?  If we can’t know the future, we can at least rely on historical patterns of behavior.  One such pattern, with a pedigree of more than eight decades, is the observation that most active managers underperform passive benchmarks.  There are good theoretical reasons why this should be true, stemming most convincingly from the zero-sum nature of professional investment management.  If I’m to be above average, someone else has to be below average, and the weighted sum of the winners’ outperformance is exactly equal to the weighted sum of the losers’ underperformance — before costs.  The incremental costs of active management place active investors, as a group, at a permanent disadvantage relative to their passive competitors.

The theoretical argument is borne out by a virtual catalog of empirical data, most recently including our mid-year SPIVA report for the U.S. market.  For the 12 months ended June 30, 2017, 57% of large-cap U.S. equity fund managers underperformed the S&P 500.  Current results are somewhat worse for mid- and small-cap managers, and significantly worse across all cap ranges when the time horizon extends to three or five years.

We don’t know what will happen next year; we don’t know which active managers will outperform and which will fail.  What we do know is that investors who put index funds at the core of their portfolios have outperformed most active managers most of the time.  Investors who act accordingly have the odds on their side.

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

DJSI Push Companies to Achieve the SDGs

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Manjit Jus

Managing Director and Global Head of ESG Research & Data

S&P Global

On Sept. 7, 2017, RobecoSAM and S&P Dow Jones Indices (S&P DJI) announced the results of the annual rebalancing of the Dow Jones Sustainability Indices (DJSI).  This year, a record of 942 companies (up 9 %) from around the world that had participated in RobecoSAM’s annual Corporate Sustainability Assessment (CSA) eagerly waited to learn whether they had been included in one of the most prestigious indices.

Over time, these indices have evolved into something much more than just benchmarks for sustainability-minded market participants.  These indices now serve as the gold standard for sustainability practices.  Companies use the DJSI to measure their efforts in a wide range of non-financial indicators against those of their industry peers and competitors.  As can be seen from the hundreds of press releases issued by companies, inclusion in the indices is not only a matter of pride, but it also validates their efforts to help solve some of the world’s greatest challenges.

This year brought the introduction of new criteria into the CSA, which serves as the research backbone for the DJSI and a growing number of ESG-focused products jointly offered by RobecoSAM and SPDJI.  Criteria like policy influence and impact measurement are on the pulse of what market participants are looking for in terms of forward-looking sustainability indicators.  Policy influence, for example, has traditionally been ignored in most sustainability assessments, but it deserves careful attention in terms of the potential reputational risks for companies and investors.  This year, RobecoSAM added questions to the CSA related to policy influence to get a better read on whether companies are indeed spending money on influencing policy for positive change, or whether they are in fact putting their money toward discussions that counteract positive change and hinder addressing global challenges, as outlined by the UN Sustainable Development Goals (SDGs).

Through the new questions on impact measurement, RobecoSAM identifies companies that have progressed only past measuring the monetary costs of investments made into environmental technologies or measuring the amount of carbon reduced from their operations, and to gauge the real implications and outcomes of these investments on local communities or human health, for example.  Market participants are increasingly looking for a measurable impact to be attached to their investments, and they often start by selecting companies that have begun to think about their impact in a broader sense.  The SDGs have given companies, investors, and governments a solid framework to measure their impacts against.  RobecoSAM is interested in identifying companies that truly understand that their operations, products, and services can have detrimental and positive impacts on the planet, and that these come with unique risks that need to be managed and opportunities that can be seized.

We recognize that these new CSA criteria pose challenges to companies, and that often, when it comes to policy influence, for example, companies tend to be hesitant to report on spending beyond their legal obligations.  With regard to impact measurement, many of the accepted methodologies like the Natural Capital Protocol and Social Capital Protocol are still in their infancy.  So, while in many cases company responses to these new CSA criteria were incomplete, a lot of encouraging data was collected, highlighting that companies are moving in the right direction: improved transparency and more strategic action toward achieving the SDGs by 2030.

Important legal information: The details given on these pages do not constitute an offer. They are given for information purposes only. No liability is assumed for the correctness and accuracy of the details given. The securities identified and described may or may not be purchased, sold or recommended for advisory clients. It should not be assumed that an investment in these securities was or will be profitable. Copyright© 2017 RobecoSAM – all rights reserved.

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

Correlation Analysis of VIX® and High Yield and Emerging Market Bonds

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Hong Xie

Former Senior Director, Global Research & Design

S&P Dow Jones Indices

The CBOE Volatility Index® (VIX) measures the implied volatility of the S&P 500® over a 30-day period.  It is widely followed by market participants across asset classes to gauge market sentiment.  Traditionally, fixed income market participants have incorporated it into macro analysis.

Can VIX-related products be used as hedging tools for some bond sectors that exhibit certain equity-like features?  For high yield and emerging market bonds, credit and liquidity risks are more defining than duration risk.  Dor and Guan (2017) demonstrated that equity futures can be used to hedge high yield portfolios.  We investigated a correlation analysis of high yield and emerging market bonds to VIX and VIX futures.

Based on the correlation analysis, we can make the following observations.

There is a strong correlation between high yield and emerging market bond returns (0.58 and 0.79).  This could be due to the fact that emerging market countries and corporations that issue U.S. dollar-denominated bonds are likely to be closely tied to the strength of the U.S. economy and U.S. companies.  The overlapping investor base for high yield and emerging market bonds may also compound the return correlation between these two sectors.

There is a strong correlation between high yield and emerging market bonds and the S&P 500.  In other words, returns from U.S. large-cap stocks can explain a large part of variance in high yield and emerging market bond returns.  In our observation period, 51% of (square of correlation) variance in high yield bond returns and 36% of variance in emerging market bond returns can be explained by the variations in the returns of U.S. equities.

There is a negative correlation between VIX and VIX futures and high yield and emerging market bonds.  This demonstrates that as high yield and emerging market bonds have more exposure to credit spreads than duration risk, they tend to exhibit more equity-like properties and a strong correlation with equity volatility.

It is noteworthy that VIX futures exhibits stronger negative correlation with credit bonds than VIX spot, and therefore argues for a stronger case of VIX futures as a hedging instrument for bonds.  In fact, when correlation analysis is conducted for up and down market periods separately, it can be seen that this stronger negative correlation of bonds to VIX futures than to VIX spot comes mostly from down markets (see Exhibit 2).

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