Indexology^® Blog

The means by which we communicate has grown over the past several years as a result of integration between telecommunications, media, and internet companies.  In response, S&P Dow Jones Indices and MSCI recently announced the expansion of the Telecommunications Services Sector into a new Communication Services Sector to be implemented after the close on Friday, September 28, 2018.  While the companies involved are not announced yet, there are some important things to know about how the changes may impact the indices.

As mentioned in the announcement, in order to include companies that facilitate communication and offer related content and information through various media, selected companies from the Consumer Discretionary Sector currently classified under the Media Industry Group and Internet & Direct Marketing Retail Sub-Industry along with certain companies currently classified in the Information Technology Sector, will be added to the existing Telecommunication Services Sector.

To start, here is what the Telecommunication Services Sector looks like currently:

While it may look comprehensive, there are only 3 stocks from the S&P 500 in the Telecommunication Services Sector with a combined market capitalization of $413.0 billion and average market cap of $137.7 billion for a weight of just 1.9% in the broad index.  In the greater set of market cap weighted U.S. equity indices, the sector is still relatively small.

The new Communication Services Sector will include the existing telecommunication services companies (as an Industry Group,) but also aims to reflect the integration of telecom, media and select internet companies, leading to an additional Industry Group called Media & Entertainment.  The companies that facilitate communication and offer related content and information through various mediums will be considered in the new sector, depicted below.

The expansion of the Telecommunication Services Sector into the new Communication Services Sector has the potential to add 16 new stocks in the S&P 500 from the current Media Industry Group with an average market cap $39.5 billion for a total market cap of $632.2 billion.  There are also 6 small caps with an average market cap of $1.2 billion and total market cap of $7.2 billion, as well as 8 mid cap stocks with an average market cap of $3.8 billion and total market cap of $30.4 billion from the Media Industry Group.  The Home Entertainment Software Sub-Industry will also add another 2 large caps totaling $82.0 billion and 1 mid cap stock worth $12.6 billion, with further possible additions from the Internet Software & Services Sub-Industry,  Internet & Direct Marketing Retail Sub-Industry and the Information Technology Sector.

Although no announcements have been made on the exact companies moving into the new sector yet, based on the information in the announcements, a hypothetical approximate of the new communication services sector can be examined.  In the following illustrations of hypothetical backtests, the approximation of a possible communication services sector index is based on 10 years of historical monthly data of the current Telecommunication Services Sector, Media Industry Group, Internet Software & Services Sub-Industry and the Home Entertainment Software Sub-Industry with fixed weights shown in the table above.  The S&P MidCap 400 Home Entertainment Software Sub-Industry is excluded from the analysis from insufficient history.

The results show the cumulative total returns of the hypothetical backtest of the new Communication Services Sector outperformed the Telecommunication Services Sector over the past 10 years in each of the large, small and mid cap indices.  Though the large caps of the new sector outperformed by 7.3% annualized and the mid caps outperformed 7.5% annualized, the small caps outperformed by 12.0% annualized.  The new small cap sector hypothetically would have returned a positive annualized return and the mid caps would have held up in the past year.

In every time period measured annualized over 1, 3, 5 and 10 years, the new Communication Services Sector outperformed the Telecommunication Services Sector.   Not only did it outperform but the risk was also reduced over every time period, with the exception of the 10 year annualized risk for the large cap sector.  The added volatility comes from the relatively large weight and volatility from the S&P 500 Internet Software & Services Sub-Industry that overpowers the moderately low correlation.

However, when examining the returns on an annual basis, the mid caps do not fare as well.  In the past 10 years, the S&P 400 Telecommunication Services Sector outperformed the hypothetical new mid cap Communication Services Sector six times.  Despite this, the new sector on average outperformed by 6.4% in a calendar year, mainly from strong outperformance in 2009 and 2017.   That said, the hypothetical new Communication Services Sector outperformed the current Telecommunication Services Sector 9 of 10 years in small caps and 7 of 10 years in large caps, with average outperformance of 11.8% and 11.9%, respectively.

Overall, it seems the higher returns with lower volatility is an attractive result of the expansion of the current Telecommunication Services Sector into the new Communication Services Sector.  While the new sector will be more diversified with lower volatility, there is still room for diversification across the market capitalizations, but especially between large and small caps.

*New definitions for Sub-Industries:
Integrated Telecommunication Services: Operators of primarily fixed-line telecommunications networks and companies providing both wireless and fixed-line telecommunications services not classified elsewhere. Also includes Internet Service Providers offering internet access to end users.
Wireless Telecommunication Services: Providers of primarily cellular or wireless telecommunication services. New definition removes “including paging services.”
Publishing: Publishers of newspapers, magazines, and books in print or electronic formats. New definition removes “and providers of information.” Also, the current Publishing Sub-Industry is part of the Consumer Discretionary Sector, Media Industry Group and Media Industry.
Movies & Entertainment: Companies that engage in producing and selling entertainment products and services, including companies engaged in the production, distribution and screening of movies and television shows, producers and distributors of music, entertainment theaters and sports teams. Also includes companies offering and/or producing entertainment content streamed online. The current Movies & Entertainment Sub-Industry is part of the Consumer Discretionary Sector, Media Industry Group and Media Industry, but will move out of the Media Industry and into the Entertainment Industry.
Interactive Home Entertainment: Producers of interactive gaming products, including mobile gaming applications. Also includes educational software used primarily in the home. Excludes online gambling companies classified in the Casinos & Gaming Sub-Industry.  The current Home Entertainment Software Sub-Industry that is part of the Software Industry, Software & Services Industry Group and Information Technology Sector, will be included in the new Interactive Home Entertainment Sub-Industry.
Interactive Media & Services: Companies engaging in content and information creation or distribution through proprietary platforms, where revenues are derived primarily through pay-per-click advertisements. Includes search engines, social media and networking platforms, online classifieds, and online review companies. Excludes companies operating online marketplaces classified in Internet & Direct Marketing Retail.  Given the discontinuation of the current Internet Software & Services Sub-Industry and Industry in the Software & Services Industry Group and Information Technology Sector, and commonality in definition including “revenues from online advertising,” some of these companies may move into the new Interactive Media & Services Sub-Industry.

This was written by product management and based only on publicly announced data and not a product of GICS, IMPG or Index Governance.

There’s still some time remaining in 2017, but if it goes the way the year has thus far, this will be the least volatile year for the S&P 500 in 22 years. Given this context, selection to the S&P 500^® Low Volatility Index (an index of the 100 least volatile stocks in the S&P 500) recently has mostly been about which stocks have declined in volatility the most. In each of the last four rebalances, average realized volatility for the stocks in Low Vol has declined compared to the previous rebalance.

In the latest rebalance, Utilities regained its usual prominence, adding 5%; at 22% of Low Vol, it is currently the biggest sector in the index. This came mostly at the expense of Consumer Staples, whose weight declined to 9% from 13%. Real Estate’s weight doubled to 6%.  Curiously, although underweighted compared to the S&P 500, Technology maintains a significant weight in Low Vol (the sector’s standing ballooned in the rebalance in May 2017.)

As a rule of thumb, sector level volatility usually provides good insight into the S&P 500 Low Volatility Index, even though the index’s methodology is entirely focused at the stock level. For the latest rebalance, however, sectoral volatility was only part of the picture. For the year ended October 31, 2017, all sectors declined in volatility with the exception of Technology and Telecom. Unsurprisingly, Telecom has left Low Vol altogether.

Volatility at the sector level declined the most for Energy, but there was little change in Energy’s weight in Low Vol from the previous rebalance. Meanwhile, volatility at the sector level rose for Technology, yet there was also little change in its weight in Low Vol. This would suggest that there was a wide range of volatility within both sectors, and that stock selection was more meaningful than the sectoral effect.

On Nov. 8, 2016, Mr. Narendra Modi came on national television and announced that at the stroke of midnight, 500 and 1,000 rupee notes would no longer be legal tender.  These notes constituted 86% of the total currency in circulation.  This announcement was by far one of the boldest economic decisions taken in recent years.  The rationale for this unexpected decision was to remove counterfeit currency notes from the system, end the parallel black market economy, and digitize the Indian economy.

One year later, the topic of demonetization is still being discussed and debated across the length and breadth of India.  While many support this bold move, there are others who criticize it.  Wherever this debate goes, it’s easy to see that capital markets in India have been on a roll over the past year and have given exponential returns across size, segments, and sectors.

In this blog, we will analyze how capital markets in India have performed since the demonetization announcement was made in November 2016.

Exhibit 1 and Exhibit 2 showcase the one–year, post-demonetization returns for the four leading size indices in India.

Source: S&P Dow Jones Indices LLC.  Data from Nov. 8, 2016, to Nov. 8, 2017.  Past performance is no guarantee of future results.  Table is provided for illustrative purposes.

Exhibit 2: Index Total Returns

Source: S&P Dow Jones Indices LLC.  Data from Nov. 8, 2016, to Nov. 8, 2017.  Index performance based on total return in INR.  Past performance is no guarantee of future results.  Chart is provided for illustrative purposes.

From Exhibits 1 and 2, we can see that all four indices have given high returns.  Returns have been promising for large-, mid-, and small-cap segments.  The returns of the small- and mid-cap segments have been better than the large-cap segment.  The S&P BSE SmallCap and S&P BSE MidCap gave one-year absolute returns of 35.05% and 28.17%, respectively, while the S&P BSE LargeCap and S&P BSE SENSEX gave returns of 23.19% and 21.96%, respectively.

Exhibits 3 and 4 showcase the one-year, post-demonetization returns for the 11 leading sector indices in India.

Source: S&P Dow Jones Indices LLC.  Data from Nov. 8, 2016, to Nov. 8, 2017.  Past performance is no guarantee of future results.  Table is provided for illustrative purposes.

Exhibit 4: Index Total Returns

Source: S&P Dow Jones Indices LLC.  Data from Nov. 8, 2016, to Nov. 8, 2017.  Index performance based on total return in INR.  Past performance is no guarantee of future results.  Chart is provided for illustrative purposes.

From Exhibits 3 and 4, we can see that barring one index, all sector indices have given positive returns. The S&P BSE Realty gave the best one-year absolute return of 57.05%, followed by the S&P BSE Energy and S&P BSE Telecom, which had one-year absolute returns of 46.01% and 42.93%, respectively.  The S&P BSE Healthcare was the worst-performing index, with a return of -7.44%.

To summarize, we can say that the bulls have had their way during the 12-year period since the announcement of demonetization was made, and indices across various size segments and sectors have given exponential returns.

China’s lackluster performance has made it the worst-performing country in the Pan Asian bond market this year.  While China has been among the top three outperforming regions in the past few years, it has significantly lagged its peers in 2017.  Indonesia, as represented by the S&P Indonesia Bond Index, rose 12.6% YTD as of Nov. 10, 2017, while India (represented by the S&P BSE India Bond Index) gained 4.8% in the same period (see Exhibit 1).

The widening access that Bond Connect announced in July brought positive momentum to the market and helped recover the losses from May.  However, onshore bonds are still in the negative territory compared with this time in 2016.

In fact, sell-offs in China onshore bonds continued to make to the headlines as the deleveraging campaign and liquidity concern lingered.  As represented by the S&P China Bond Index, the one-year total return was down 1.75% (see Exhibit 2).

The S&P China Government Bond Index dropped 2.35% during the same period, underperforming the S&P China Corporate Bond Index.  According to the S&P China Bond Index, government bonds represented 68% of the overall market.  There are reports that market participants are switching to short-term bank debts, as they tend to offer better yields and liquidity.

Despite its performance, China bond yield is attractive, considering its relatively short duration.  As of Nov. 10, 2017, the yield-to-worst of the S&P China Bond Index was 4.5%, which widened 150 bps over the 12-month period, with a modified duration of 3.86.

Exhibit 1: Total Return of the S&P Pan Asia Bond Indices in 2017

Exhibit 2: Total Return of the S&P China Bond Index

Exhibit 3: Yield-to-Worst of the S&P China Bond Index

At the most recent National AFORES convention, held jointly with FIAP International in Mexico City at the end of October 2017, Latin American institutional investors continued to show increasing interest in ESG-related topics and this was evident in the conference agenda.  In particular, the participants spoke about the following topics.

• Impact reporting: The ability to measure and quantify the sustainability of their current investment portfolios.
• Relevant benchmarking: Incorporating relevant benchmark indices for comparison.
• ESG implementation: Ensuring ESG implementation into the multi-step investment process and quantifying the benefits of doing so.

As highlighted in a recent research paper, Stepping Up to Carbon Transparency, S&P Dow Jones Indices has been at the forefront of sustainability-related educational efforts.  We have recently started to report sustainability metrics as part of an index’s characteristics to support and promote ESG transparency.

In this blog, we use the “carbon footprint”[1] measurement provided by Trucost to understand how much carbon reporting has evolved in Mexico, using the country’s headline equity index, the S&P/BMV IPC, as an example.  Trucost measures the carbon footprint as the aggregation of operational and first-tier supply chain carbon footprints of index constituents per USD 1 million invested.

In 2007, there were only six IPC companies with information on their carbon footprint, of which 100% was estimated by Trucost using sector-related information.  Reflecting the growing market’s needs and interest, the carbon footprint reporting of this local index has increased from 17% in 2007 to nearly 100% in September 2017.  It is important to note that the coverage has not only increased, but the method of obtaining the carbon data has also evolved (see Exhibit 1).

At the start of 2007, 100% of the carbon data was estimated, whereas after 10 years, by September 2017, 14.7% of the companies were fully disclosing their carbon information.  More specifically, 38.24% was estimated from companies’ partial environmental and financial disclosures, 8.82% of the companies in the index were estimated using previous disclosures, and 38.24% was estimated using the sector breakdown.  This is a clear indication that Mexican companies are recognizing the importance of environmental data disclosure in financial reporting.

Currently, carbon data is available for 34 of the 35 companies in the S&P/BMV IPC.  When the data is broken down by sectors, we can see that some sectors, due to the nature of their businesses, have substantial carbon footprints compared to others.  As a comparison, we stack up the relative carbon intensity of the sectors in Mexico to those of the U.S., as measured by the S&P 500^® (see Exhibit 2).

The top three carbon-intensive sectors in Mexico, on average, are utilities, materials, and industrials.  Utilities comes in first place with 2,394 tons of CO2e emissions per USD 1million invested, even though the sector only represents less than 2% of the S&P/BMV IPC.  Materials comes in second, with roughly 1,329 of CO2 emissions per USD 1 million invested on average, while accounting for roughly 17.52% of its benchmark as of Sept. 29, 2017.  Industrials has about 613 tons of CO2 emissions per USD 1 million invested, on average, with the sector representing about 11.359% of its benchmark.

In a follow-up blog, we will provide a time-series analysis of the carbon footprint of companies that are part of the S&P/BMV IPC to highlight how the Mexican market has evolved.

[1]   Operational and first-tier supply chain greenhouse gas emissions.  For more information, please visit: www.spdji.com/esg-metrics.