Investment Themes

Sign up to receive Indexology® Blog email updates

In This List

Impact of Allocation and Security Selection Decisions on Active Fund Performance: Evidence from the U.S. SPIVA Scorecard

The Dow Crosses 23,000

Style Drift of Active Funds Domiciled in India

U.S. Corporate Debt Issuance on Pace for Record Year

Capitalization and Its Discontents

Impact of Allocation and Security Selection Decisions on Active Fund Performance: Evidence from the U.S. SPIVA Scorecard

Contributor Image
Ryan Poirier

Senior Analyst, Global Research & Design

S&P Dow Jones Indices

two

The release of the SPIVA U.S. Mid-Year 2017 Scorecard provided a welcoming dose of optimism for proponents of active management.  One statistic, which was picked up heavily by financial media (Financial Times Article) and market participants, is that 52.49% of All Domestic Funds managed to beat the S&P Composite 1500® (the designated benchmark).  The conversation thereafter sounds something similar to the following: “Active management is back…”

A single SPIVA statistic should not be seen as a full representation of the report.  The SPIVA Scorecard is meant to be a tool viewed in its entirety rather than cherry picking the (very first) data point in the report.  For example, the All Domestic Funds category comprises individual funds investing against their respective cap ranges, and it is then aggregated and compared against the S&P Composite 1500.  This means that funds investing in domestic small-cap equities are being compared against an index with a large-cap tilt.  The effective difference in benchmark performances was 22.47% (S&P SmallCap 600®) versus 18.09% (S&P Composite 1500), certainly a much lower bar to clear.  With that in mind, the focus should be on the relative performance of managers across various capitalization segments or the style against their respective benchmarks.

Despite this clarification, a fair amount of optimism was provided by the results in the domestic large-cap equity space.  With only 56.56% of large-cap active managers underperforming the benchmark for the one-year period ending June 30, 2017, it marked a substantial reversal of fortune from the results seen at mid-year and year-end 2016, with 66% and 84.62% of the managers underperforming as of Dec. 31, 2016, and June 30, 2016, respectively.

In addition to improvement in relative performance figures, large-cap equity managers also appeared to benefit from better security selection skills (see Exhibit 1).  The dark blue bar represents the portion of the excess return above the benchmark coming from security selection within each GICS sector.  The light blue bar measures the portion of excess returns coming from sector allocation decisions.  They both represent active returns stemming from managers’ decisions.  The numbers below and above the chart represent the total return of the S&P 500® over the past 12-month period.

While both allocation and security selection effects are active decisions that contribute to active returns, we can observe that a cumulative negative 12 months of returns in the market is typically followed by managers adding value with allocation.  This may be a consequence of managers avoiding certain volatile sectors.  One of the perceived benefits of active management is that it provides cushion during market downturns.  To confirm this, we examined the six-month periods between Dec. 31, 2000, and June 30, 2017, and separated the excess returns of large-cap managers during up and down markets.  What we can see from Exhibit 2 is that managers, on average, do poorly in regard to stock selection decisions during down markets.  The value that is added during up market periods (average annual active returns of 19 bps) is negated by the -54 bps that they subtract when the market is down.  This is primarily driven by the poor stock selection (-70 bps) during down periods.

Based on the recent SPIVA U.S. Scorecards, actively managed domestic equity funds appear to have had a positive trend over the past three semiannual periods.  While the results are a welcome change and demonstrate that active allocation and security selection decisions have been adding positive value, market participants may want to consider beyond short-term results and examine managers’ performance during various market environments.  As we have demonstrated, actively managed funds, on average, have not provided positive excess returns during down markets, driven primarily by poor security selection.

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

The Dow Crosses 23,000

Contributor Image
Jamie Farmer

Chief Commercial Officer

S&P Dow Jones Indices

two

Today, the Dow Jones Industrial Average closed above 23,000 for the first time – offered here are a few factoids associated with that milestone:

  • A Record – there have been four (4) 1000 point thresholds crossed in 2017, the most of any year since the DJIA’s inception in 1896.
  • Less Impact Per Milestone – of course, as the Average gains in value each 1000 points represents a smaller percentage movement. In this case, the move from 22,000 to 23,000 results in a 5.18% return.
  • A Steady Advance – there have been 51 new highs achieved year to date, the most since 2013 when the DJIA struck a new high 52 times. Prior to that, the most new highs were marked in 1995 (69 new highs).

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

Style Drift of Active Funds Domiciled in India

Contributor Image
Akash Jain

Associate Director, Global Research & Design

S&P BSE Indices

two

Style consistency analysis is an essential element of the SPIVA® India Scorecard that helps evaluate the percentage of funds that retained the same investment style classification throughout the investment horizon.  Other than performance and survivorship, the style consistency of funds is an important metric for market participant that can influence their asset allocation decisions.  In the SPIVA India Mid-Year 2017 Scorecard, we observed low style consistency for the five-year period across most fund categories, except the Indian ELSS (see Exhibit 1).

As of June 2012, there were 161 Indian Equity Large-Cap funds available for investment.  Out of these 161 funds, 34 funds were either merged or liquidated over the five-year period ending June 2017, which led to a survivorship rate of 78.88%.  Of the remaining 127 funds, another 68 drifted in style during the five-year period, resulting in a low style consistency of 36.65%.

Similarly, a low style consistency was observed for the Indian Equity Mid-/Small-Cap and Indian Composite Bond categories, which were 49.25% and 41.00%, respectively, over the five-year period. Over the same horizon, only Indian ELSS funds were style consistent.

Exhibit 1: Survivorship and Style Consistency Over a Five-Year Investment Horizon
FUND CATEGORY NO. OF FUNDS AT START SURVIVORSHIP (%) STYLE CONSISTENCY (%)
Indian Equity Large-Cap 161 78.88 36.65
Indian ELSS 36 100.00 100.00
Indian Equity Mid-/Small-Cap 67 85.07 49.25
Indian Government Bond 53 62.26 60.38
Indian Composite Bond 100 86.00 41.00

Source: S&P Dow Jones Indices LLC, Morningstar, and Association of Mutual Funds in India.  Data as of June 30, 2017.  Past performance is no guarantee of future results.  Table is provided for illustrative purposes.

Exhibits 2 and 3 investigate further into Indian Equity Large-Cap and Indian Equity Mid-/Small-Cap funds that survived the five-year investment horizon but were style inconsistent during this period.  In the Indian Equity Large-Cap category, 68 funds changed their Morningstar category definitions[1] during the five-year investment horizon. Of these funds, 43 were reclassified to India Fund Flexicap, whereas 15 others were reclassified as India Fund Sector – Infrastructure, as per Morningstar categories as of June 2017.[2] In the case of Indian Equity Mid-/Small-Cap, 24 of the 67 funds were style inconsistent; 22 of these funds were reclassified as India Fund Flexicap.

Consistency in fund style is important because a change in investment style alters the risk/return characteristics of the fund.  Funds with inconsistent style may reduce the effectiveness of asset allocation decisions.

Exhibit 2: Style Shift Breakdown of Active Funds Over a Rolling Five-Year Investment Horizon
DATA POINT                                       SPIVA CATEGORIES
INDIAN EQUITY LARGE-CAP INDIAN EQUITY MID-/SMALL-CAP
Number of funds as of June 2012 161 67
Number of funds that survived until June 2017 127 57
Number funds that survived and were style consistent until June 2017 59 33
Number funds that survived and were style inconsistent until June 2017 68 24

Source: S&P Dow Jones Indices LLC and Morningstar.  Figures based on SPIVA India Mid-Year 2017 Scorecard.  Table is provided for illustrative purposes.

Exhibit 3: Movement of Funds to New Categories
MORNINGSTAR CATEGORY                                      SPIVA CATEGORIES
INDIAN EQUITY LARGE-CAP INDIAN EQUITY MID-/SMALL-CAP
India Fund Sector – Infrastructure 15 1
India Fund Flexicap 43 22
India Fund Moderate Allocation 3 1
India Fund Small-/Mid-Cap 3
No Category Available in Morningstar 4

Source: S&P Dow Jones Indices LLC and Morningstar.  Figures based on SPIVA India Mid-Year 2017 Scorecard.  Table is provided for illustrative purposes.

[1]   http://advisor.morningstar.com/Enterprise/VTC/CategoryDefinitions_India_April_2016.pdf

[2]   Please refer the SPIVA India Mid-Year 2017 Scorecard for current and historical mapping of SPIVA and Morningstar categories.

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

U.S. Corporate Debt Issuance on Pace for Record Year

Contributor Image
Jason Giordano

Director, Fixed Income, Product Management

S&P Dow Jones Indices

two

U.S. corporations continue to take advantage of the accommodative conditions created by a protracted period of low interest rates and strong market participant demand.  As of Oct. 1, 2017, U.S. investment-grade corporate debt issuance surpassed USD 1 trillion—three weeks ahead of 2016’s pace.  Additionally, the amount of speculative-grade corporate debt issued through the first three quarters of 2017 is 17% higher than it was after the first three quarters of 2016.  Combined, U.S. corporate issuance is on pace for another record year, which would mark the sixth consecutive year of increased corporate debt issuance (see Exhibits 1 and 2).

Corporations have not only been issuing more debt each year, but they’ve also been extending the maturities in an effort to lock in low funding costs for several decades.  In January 2017, Microsoft Corp issued a total of USD 7.5 billion of 30-year bonds with an average coupon of 4.2%.  One month later, in February 2017, fellow ‘AAA’-rated Johnson & Johnson issued USD 2.5 billion of 30-year bonds with an average of coupon of 3.7%.  Nearly 20% of the USD 1 trillion investment-grade debt issued YTD has been in 30-year term deals.  The average maturity of corporate issuances has grown significantly over the past 15 years (see Exhibit 3).

As a result of the continued increases in annual issuance amounts combined with extensions in average maturities, the total amount of U.S. corporate debt outstanding has more than tripled over the past 10 years.  The par amount outstanding of investment-grade corporate debt, as measured by the S&P U.S. Investment Grade Corporate Bond Index, has increased over USD 4 trillion since September 2007, while the amount of speculative-grade outstanding, as measured by the S&P U.S. High Yield Corporate Bond Index, has increased by USD 800 billion.  Over 60% of this increase can be accounted for by the companies in the S&P 500, as tracked by the S&P 500 Bond Index (see Exhibit 4).

Given the record amount of corporate debt outstanding, U.S. corporations have increased the degree of financial leverage to well above pre-crisis levels.  Perhaps more concerning is how corporations have chosen to use the proceeds of this record debt.  Most companies have favored short-term shareholder wealth (in the form of dividends, share buybacks, and M&A activity) over longer-term capital expenditures.  As U.S. equity markets continue to set record highs (in what seem to be weekly events), market participants may want to look at corporate capital management and, more importantly, how changes in corporate capital structures can potentially drive equity valuations.

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

Capitalization and Its Discontents

Contributor Image
Craig Lazzara

Managing Director and Global Head of Index Investment Strategy

S&P Dow Jones Indices

two

Last week, readers of the Financial Times were regaled by suggestions that capitalization-weighted index funds were “hugely biased,” “undiversified,” and “too trusting of the market’s judgment on a handful of very large stocks.”  Criticisms of cap weighting aren’t new, of course, and at least in the near term seem not to have been very effective at deterring flows into passive strategies.  Nonetheless it may be worth asking how cap weighting achieved its prominent role in the investment firmament.

It was not, we hasten to say, because a handful of index providers decided to foist a flawed concept on the unsuspecting masses.  Indices began when journalists and stock exchanges wanted to communicate how the stock market had performed.  This raised an obvious question: how to combine the returns of a number of individual issues to summarize “the market?”  Combining returns requires choosing how each individual stock’s return is to be weighted.

There are a number of ways to weight individual returns, some more computationally convenient than others.  A comprehensive capitalization-weighted index will tell us the performance of the average investor, weighted by the amount of capital invested.  That is the key informational attribute that makes capitalization-weighted indices economically useful.  Note that this has nothing to do with index funds.  The S&P 500 launched in 1957, and its earliest cap-weighted predecessor in 1923, long before anyone thought of using indices as the basis for investment products.

Serendipitously, however, capitalization weighting turns out to have three characteristics that make it particularly attractive for index fund managers:

  • It is, in economists’ jargon, “macro-consistent.”  If they wanted, all investors in a market could each hold a cap-weighted index fund.  Doing so does not require an offsetting tilt from another investor.  (In contrast, e.g., if I want to tilt toward value, someone else has to tilt toward growth.)
  • Cap-weighted portfolios are relatively easy to maintain.  Unless the underlying index changes, a properly-constructed cap-weighted index fund is not required to transact.  Other weighting schemes (e.g., equal weighting or factor weighting) inherently require more turnover.
  • Sharpe’s famous “Arithmetic of Active Management” concludes that “after costs, the return on the average actively managed dollar will be less than the return on the average passively managed dollar.”  The average passively managed dollar, in this formulation, is capitalization weighted.  Sharpe’s analysis does not hold for any other weighting scheme.

None of these arguments imply that capitalization weighting is appropriate for all investors in all circumstances.  But its popularity is not arbitrary or inexplicable.  We live in a capitalization-weighted world, and cap-weighted index funds are a simple reflection of that reality.  The law of gravity does not require our consent for its efficacy.  Neither does capitalization weighting.

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