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Alternative Index Choices for Canada

Optimal Timing and Strategy for Claiming One’s Social Security Retired-Worker Benefits

U.S. Preferred Stocks Gaining Popularity in Asia

Stock Picking AI? Elementary, My Dear Watson

TIPS Improve Income Stability For Lifestyle Goals

Alternative Index Choices for Canada

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Kevin Horan

Director, Fixed Income Indices

S&P Dow Jones Indices

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The ever-changing environment of business has led to significant changes in the index world.  As with any market, consumers or market participants require more options in order to operate in such a fast-paced environment.  For many years, Canadians have relied on a singular index provider to represent their market.  As the pressures of the current business environment require cost controls, additional service demands, or regulatory review, the need for additional service and provider options increases.

The S&P Dow Jones Indices series of Canadian indices offers competitive alternatives for benchmarking, product issuance, and data needs.  The minimum par amount outstanding required for sovereign bonds is CAD 1 billion.  With the exception of sovereign bonds, the minimum par amount outstanding required for a bond to be eligible for index inclusion is CAD 250 million.

In comparison, the FTSE TMX Canada Universe Bond Index requires CAD 100 million for corporate bonds and CAD 50 million for government bonds, which include municipal and provincial bonds.  The higher minimum par amount outstanding enables S&P DJI’s indices to capture the market’s performance while also providing a universe of more liquid bonds.

Exhibit 1 shows a structural and return comparison between the two index providers of comparable bond universes.

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

Optimal Timing and Strategy for Claiming One’s Social Security Retired-Worker Benefits

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Peter Tsui

Director, Global Research & Design

S&P Dow Jones Indices

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The decision to claim social security benefits is not as straightforward as it seems and involves a number of key considerations.  Given that it is a one-time decision and locks in one’s benefits permanently, aside from periodic cost of living adjustments, it is important for retirees to rethink whether there is an optimal timing and strategy for claiming Social Security benefits.

As a source of retirement income, the rules for claiming Social Security benefits are fairly straightforward.  The rules are designed such that they are actuarially equivalent, no matter when one chooses to receive the benefits.  Once one has earned enough credits to qualify for benefits, retired-worker benefits can be claimed as early as 62 or as late as 70.  Collecting Social Security benefits early will permanently reduce one’s monthly income amount, while choosing to delay benefits has the effect of a permanent increase.  Exhibit 1 shows the reductions and increases at different ages when filing for Social Security benefits for someone whose full retirement age is 66.

Collecting Social Security benefits early results in a benefit reduction of 6.67% per year for up to 36 months before full retirement age, and a rate of 5% per year beyond that.  Conversely, choosing to delay benefits after full retirement age has the effect of an 8% increase per year, and this delayed retirement credit can accumulate until age 70.  Beyond age 70, no more credits are granted.

The Social Security Administration does not advocate any particular age on the timing of the claiming of the benefits.  However, it does publish the benefit claiming data in its Annual Statistical Supplements report.  The Center for Retirement Research at Boston College analyzed the data for the 2013 claim year.[1]  The results are presented in Exhibit 2.

Despite the fact that the benefit amounts would be significantly higher when delayed beyond the full retirement age, 90% of retirees begin collecting Social Security benefits at or before their full retirement age.  It is fair to say that most retirees choose not to maximize their Social Security benefits.

While there is no one-size-fits-all  single timing strategy, retirees who are considering claiming Social Security benefits should consider the following key factors to weigh any tradeoffs.  The relevant factors to consider are:

  1. level of the benefits,
  2. longevity or mortality assessment,
  3. current financial needs, and
  4. marital status.

[1]   Source: “Trends in Social Security Claiming” by Alicia H. Munnell and Anqi Chen, Center for Retirement Research at Boston College, May 2015, Number 15-8)

[2]   The Full Retirement Age (FRA) increased by two months for workers who turned 65 in 2003 and continued to rise at this pace each year until reaching 66. As a result of the shift in the FRA, Table 6.B5 in the Annual Statistical Supplement 2014, Social Security Administration, reports distributions from age 65 to the FRA and at the FRA. Exhibit 2 combines these two claiming groups into one group: FRA (65-66).

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

U.S. Preferred Stocks Gaining Popularity in Asia

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Michele Leung

Director, Fixed Income Indices

S&P Dow Jones Indices

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The total return of U.S. preferred stocks, represented by the S&P U.S. Preferred Stock Index, gained 8.57% YTD as of Oct. 20, 2017.  U.S. preferred stocks are perceived to be an attractive investment, as they have historically offered higher yields than other asset classes, especially when the global rates remain low.  The indicative yield of U.S. preferred stocks was 5.90% YTD, which offered a significant yield pick-up over investment-grade corporates and comparable yield to high-yield bonds.

The spread is even higher when it is compared with Pan Asian bonds, as tracked by the S&P Pan Asia Bond Index.  The yield-to-maturity was about 4.30%, while the yields of individual countries like Taiwan and Korea were lower.  The yield-to-maturity of the S&P Taiwan Bond Index and the S&P Korea Bond Index were 0.96% and 2.20%, respectively.

In addition to the higher yields, Asian market participants could also benefit from the market transparency and ease of trading, as most of the U.S. preferred stocks are listed and tradable on exchanges. Fundamentally, a preferred stock is a hybrid security that has characteristics of stocks and bonds.  Preferred stocks pay dividends at a specified rate and receive preference over common stocks in terms of dividend payments and liquidation of assets.

Exhibit 1: Yield Comparison

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

Stock Picking AI? Elementary, My Dear Watson

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Tim Edwards

Managing Director, Index Investment Strategy

S&P Dow Jones Indices

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Keen watchers of the ever-developing exchange-traded product space may have noticed an intriguing development last week, as the first purely “artificial intelligence”-based stock-picking ETF launched.  Powered by IBM’s “Watson” platform, the fund sponsors claim to use a proprietary quantitative model to select stocks that will outperform, based on machine learning applied to vast data sets.

One cannot help wondering if they have missed a trick: as far as I can tell, their algorithm does not explicitly allow for the possibility that – rather than trying to pick stocks – a truly intelligent option might be to invest  their entire portfolio in a low cost index fund, or otherwise replicate the market portfolio.  Certainly, buying such funds is nowadays as easy as buying stocks, while the data would suggest that this is more than a viable option.

Perhaps, one day, another sponsor will create a fund including this option.  Perhaps, one day, our machines will be so advanced that they can draw conclusions from the entire range of academic and practitioner studies that examine the performance of stock-picking compared to low-cost passive investing.  Perhaps, if it helps, they can check their conclusions 10,000 times a second.

Such a fund may never exist, but if it one day does, I hope they call it “Holmes”.

 

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

TIPS Improve Income Stability For Lifestyle Goals

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Jodie Gunzberg

Managing Director, Head of U.S. Equities

S&P Dow Jones Indices

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Commodities are a direct way to protect against inflation since they are the natural resources that build society.  The same food and energy that is in CPI (Consumer Price Index from the Bureau of Labor Statistics,) is in the commodity indices like the S&P GSCI and DJCI, and more energy has provided more inflation protection since energy is the most volatile component of CPI.

In this video featuring Bob Greer and Boris Shrayer, the link between pension liabilities, inflation and commodities is discussed.  They say commodities can be a nearly perfect hedge for real lifestyle costs when buying food and gasoline. However, pension assets need to accumulate more if they will pay out more in liabilities.  The conversation extends beyond pensions to endowments and foundations where if levels of gift giving and supporting of staff at universities are maintained, then purchasing power needs to be preserved as inflation rates rise.  The link between inflation and liabilities can be complex, where commodities are an imperfect hedge since some inflation from commodities may not move exactly with all types of inflation, like wage inflation for example.

One of the important things that Boris points out is that this inflation doesn’t just apply to institution but it impacts individuals “or anybody.”  Without knowing for sure how inflation and interest rates might move in the future, strategies have evolved to minimize uncertainty around how much an account balance is worth as an income stream.  For example, the conversation has changed from “how big should your 401K be at retirement?” to “what percentage of your current income do you need to replace annually for retirement (inflation protected)?”  The latter style is akin to the defined benefit/pension conversation and much more relatable for retail clients.  Why worry about hitting a certain savings number/account size when you’re not clear what the withdrawal rate will be or how much impact inflation may have during your retirement?

Two main applications enable this switch, and are implemented in the S&P STRIDE (Shift To Retirement Income and Decumulation) indices.  The first uses a process that is analogous to dollar cost averaging into income producing assets.  It is a three-phased glide path that is innovative because it not only de-risks the allocation automatically as investors pass TO and THROUGH retirement, but it also addresses inflation risk.

The three phases are:

  1. Accumulation. This consists of a conventional target date glide-path using stock and nominal bond indices.
  2. Transition. The index weight is gradually shifted from the target date glide-path to a pool of constituents that secure real future income.
  3. Decumulation. The income producing constituents are divested, modelling retirement income cash flows.

The table below shows what allocations look like at different ages with the other significant breakthrough that is the addition of TIPS (Treasury Inflation-Protected Securities.)  Using a glide path approach with TIPS may help financial planners to provide clients a higher degree of stability when predicting inflation adjusted income during retirement.

Source: S&P Dow Jones Indices. S&P STRIDE Methodology at: https://us.spindices.com/documents/methodologies/methodology-sp-global-sovereign-inflation-linked-bond-indices.pdf?force_download=true

The index series builds in a liability driven investment (LDI) strategy by shifting from equities and fixed income to TIPS, that is implemented during the transition phase. Notice there is a 75% allocation to TIPS by age 65, which is at the age when many individuals retire, and the TIPS allocation increases for another 25 years.

Interestingly, the S&P Target Tuition Inflation Index, that aims to grow with tuition inflation over the long term, has a similar allocation to TIPS as in the latter part of S&P STRIDE.

Source: S&P Dow Jones Indices. S&P Target Tuition Inflation Index Methodology. http://us.spindices.com/documents/methodologies/methodology-sp-target-tuition-inflation-index.pdf?force_download=true

Although the tuition inflation has risen much more than general CPI, a large component of the tuition inflation increase is correlated with general CPI. However, the time horizon for college tuition is shorter than for the whole three-stage retirement life-cycle, so there is a constant 80% allocation to TIPS in the S&P Target Tuition Inflation Index to help preserve the capital while the remainder of the index allocates between stocks and nominal bonds, resulting in an index that has grown with tuition inflation.

Source: S&P Dow Jones Indices and the U.S. Bureau of Labor Statistics. Launch Date of S&P Target Tuition Inflation Index is Aug 31, 2017. All information for an index prior to its Launch Date is back-tested, based on the methodology that was in effect on the Launch Date. Back-tested performance, which is hypothetical and not actual performance, is subject to inherent limitations because it reflects application of an Index methodology and selection of index constituents in hindsight. No theoretical approach can take into account all of the factors in the markets in general and the impact of decisions that might have been made during the actual operation of an index. Actual returns may differ from, and be lower than, back-tested returns.

Whether saving for retirement or college, TIPS help change the framework from addressing the question of how big savings are at a moment in time to how much of current income needs to be saved for the goal.  Preserving purchasing power in the face of unknown interest rates and inflation can be better managed with TIPS, and can now be measured with indices using them.

I would like to acknowledge my colleague, Travis Robinson, Senior Director of Financial Advisor Channel Management at S&P Dow Jones Indices, for his contribution to this article regarding key points on S&P STRIDE.  For more information on STRIDE, register for our upcoming webinar, “Strategies for Managing Retirement Income Risk” on October 24 at 2PM ET.  

 

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