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Latin American Scorecard: Q4 2017

Unconventional Sources of Retirement Income

Large-Cap Energy Stands Out in a Year of Low Volatility

Quality Over Quantity: China’s Economic Growth Focus in 2018 – Part 1

The Passive Canon

Latin American Scorecard: Q4 2017

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Silvia Kitchener

Director, Global Equity Indices, Latin America

S&P Dow Jones Indices

Latin America closed 2017 on a high note. This is the annual edition of this report where we will review the 2017 performance of country and regional indices, as well as the best performers and those that lagged behind.

Latin America’s annualized returns, as measured by the S&P Latin America BMI (the broad regional index) and the S&P Latin America 40 (the narrow, blue-chip index), have even surpassed the S&P 500 and the S&P Global 1200, which measures the 1,200 largest, most liquid companies from around the world. Latin American regional and country indices are now showing two consecutive years of positive double-digit returns, bringing their three-year returns into positive territory. There is still some ground to cover before the 5- and 10-year returns also move to the positive side, although the gap is closing.

Despite political challenges in Brazil, elections in Chile, natural disasters in Mexico, and extraordinary circumstances of corporate corruption that affected the entire region from top to bottom, all stock markets in the region fared exceptionally well in 2017, as reflected by their respective country indices: the S&P Brazil BMI, S&P Chile BMI, Mexico’s S&P/BMV IRT, S&P Colombia BMI, and S&P/BVL Peru General. In particular, the three largest markets had the biggest impact on regional returns. Brazil, which represents nearly 58% of the S&P Latin America BMI, had an annual return of 26.1%. Chile, the third-largest market in the region by weight, had an annual return of 45.2%. Mexico, the second-largest market in Latin America, representing nearly 24%, generated a strong return of 11% for the year. Argentina was the monster (in a good way) of the region. Because the market is classified as a frontier market and not emerging, it is not currently considered part of the S&P Latin America BMI; however, it merits mentioning that its performance for the year was outstanding, at 73.1% in USD and 106% in ARS.

So, what were the drivers? Based on historical data, Latin America was the last region to catch up with other global markets. Positive global investor sentiment, good corporate valuation, along with many other accommodative financial factors (such as low market volatility, as measured by VIX®, low interest rates, low inflation) and rising commodity prices (such as gold and oil) contributed to the markets performing well in 2017. In Latin America, only 58 out of 285 companies in the S&P Latin America BMI had negative one-year price returns. This means that 85% of the companies in the index yielded positive returns. As of year-end 2017, the top 28 stocks, representing 50% of the index, had an average annual return of nearly 36%.

Economic growth has picked up in Latin America based on Q3 2017 data. GDP for the region has expanded at a stronger rate since Q1 2014,[1] leaving the previous year’s recession in the past. While analysts expect the economies to continue to grow, there is some hesitation on these projections, given the major elections coming up for Brazil, Colombia, and Mexico. New administrations can either help or hinder the necessary economic policies to continue the region’s expansion. While they seem confident, market participants are taking a moment to see what the approach will be for 2018. This certainly will be an interesting year for the region.

To see more details about performance in Latin America, please see: S&P Latin America Equity Indices Quantitative Analysis Q4 2017.

[1] Focus Economics, “Economic Snapshot for Latin America,” Dec. 7, 2017.

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

Unconventional Sources of Retirement Income

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Peter Tsui

Former Director, Global Research & Design

S&P Dow Jones Indices

The three pillars of conventional retirement income are social security retirement benefits, pensions from employment, and personal savings. There are, however, other potential sources of retirement income that are not mentioned often enough. These include (a) the cash value of one’s whole life insurance policy, (b) the home equity value of one’s residence, and (c) the pre-funded nature of the long-term care insurance policy.

Let’s dig a bit deeper into the nontraditional sources noted above.

(a) The premium for a whole life insurance policy is generally much higher than that of a term life insurance policy. Hence many tend to shy away from purchasing the whole life insurance. However, the premium paid for a whole life policy can be viewed as consisting of a premium for an equivalent term life policy plus a contribution to an investment account maintained for the insured by the insurance company. The balance in this investment account is known as the cash value of the whole life insurance policy. As time passes, if one is still alive, this cash value will also grow, due to the fact that new premiums are adding to the account balance and the entire balance is increasing at a rate tied to the performance of the insurance company’s general account.

When the insured individual gets older, say age 75, if the objective of protection is no longer an issue, the insured has the option to surrender his policy and tap into the cash value as a source of income.

(b) The home equity value of one’s residence can also be accessed by using the property as collateral for either a home equity loan or a reverse mortgage. The advantage of this type of secured borrowing is that one can continue to stay in one’s residence without resorting to a sale.

(c) The last source, the long-term care insurance policy, is intended to provide funding for healthcare-related expenses, which can be expected to be ever-present in old age. A long-term care policy, purchased when one is younger, behaves as if it’s prefunding one’s late-life healthcare expenses on a level-payment basis. In this way, even though it is a non-cash source of income, since it takes care of the healthcare-related expenses when they’re incurred, it can be thought of as a cash item. Typically, for the long-term care policy to be activated, a doctor’s approval is required by the insurance company, and the insurance company would reimburse the healthcare providers directly.

For one to feel secure in retirement, monthly cash incomes are needed to take care of both the core expenses and discretionary ones (such as for travel and entertainment). What has often been overlooked are the benefits from the unconventional sources, both as additional sources of cash (for example, from one’s cash value account or home equity loans) or as indirect non-cash contributions (such as the expenses covered by one’s long-term insurance). These additional sources of support need to be taken into account in one’s financial life planning as well.

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

Large-Cap Energy Stands Out in a Year of Low Volatility

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Anu Ganti

U.S. Head of Index Investment Strategy

S&P Dow Jones Indices

Most sentient investors are aware of the low volatility that characterizes the current environment, with the S&P 500®’s trailing twelve-month annualized volatility at approximately half its level from a year ago. This trend was driven in part by some significant negative inter-sectoral correlations, for example between information technology and real estate versus financials, and energy versus information technology (see Exhibit 1).

Going a step further at the sector level, we observe decreases in volatility across the majority of sectors. Most notably, energy had the largest decrease (see Exhibit 2).

As illustrated in the most recent sector dashboard, the S&P 500 Energy sector’s trailing twelve-month annualized volatility was 13.2% as of Dec. 29, 2017—approximately half the sector’s 23.6% volatility from the prior year, with volatility declining steadily over the past twelve months. Historically, energy volatility has ranked roughly at the median of all sectors. We witnessed an aberration in recent years, as the sector’s volatility reached peak levels. However, this trend has reverted during the past year.

Market volatility can be understood in terms of two components: dispersion and correlation. Dispersion measures the degree to which index constituents perform differently, and correlation measures the tendency of index constituents to rise or fall at the same time. The decline in energy sector volatility has been driven by declines in both correlation and dispersion.

Exhibit 3 shows that the average trailing twelve month dispersion for the S&P 500 Energy sector was 13.4% as of Dec. 29, 2017, versus 20.5% one year prior. Similarly, the average trailing twelve month correlation for the S&P 500 Energy sector was 0.43, versus 0.57 one year before.

While energy was the second-worst-performing sector in 2017, performance has picked up so far in 2018, with the sector up 5.9% for the month as of Jan. 19, 2018, aided by strengthening oil prices. Will this performance tailwind reverse last year’s decline in volatility? We shall wait and see.

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

Quality Over Quantity: China’s Economic Growth Focus in 2018 – Part 1

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Jack Jiang

Senior ETF Specialist, Index and Quantitative Investment

ICBC Credit Suisse Asset Management (International) Co., Ltd.

The Central Economic Work Conference (CEWC) was held in Beijing on 18-20 December, 2017. As the first CEWC after the 19th Party Congress, it set the tone for China’s central government’s economic policies in 2018. They are crucial to the long-term development of the world’s second-largest economy.

Highlights of the CEWC

(1) High-quality development over GDP targets

CEWC emphasized the quality of the economic development over specific GDP targets. The government will likely unveil its GDP growth target at “around 6.5%” during the National People’s Congress in March 2018 instead of “6.5% or higher if practically possible” in 2017. The government will follow its previous guideline of “making progress while maintaining stability” and keep economic growth within a “reasonable range.”

(2) Three key focuses: prevention of major financial risks, poverty alleviation, and pollution reduction

 Preventing major financial risk. The government will focus on containing major financial risks to form a “virtuous cycle” among the financial, real and property sectors, as well as within the financial system.1 There will also be increasing efforts to crack down the illegal activities in the banking, securities and insurance sectors as well as online finance.

Poverty alleviation. President Xi pledged to lift all rural residents above China’s poverty line by 2020. The central government will also step up its supervision of local government bodies while allocating more fiscal resources to welfare, education and healthcare as well as public services in rural area.

– Pollution reduction. The CEWC targeted to “significantly reduce” the gross emissions of major pollutants with a specific focus on air pollution control. Previous measures such as reducing industrial activities during the winter heating season will continue. China will also examine its industrial structure, energy structure and transportation structure in order to achieve eco-friendly development.

  (3) Monetary and fiscal policies

Monetary policy. The CEWC said China will implement prudent and neutral monetary policy2.  However, following the Fed’s rate hike decision in December, the PBoC raised interest rates on MLF and reverse repo operations by merely 5bps. The move was pre-emptive but it indicated that the PBoC is ready to use interest rates and other measures to ensure financial stability if volatilities are triggered by external factors.  

– Fiscal policy, the government will implement a proactive fiscal policy in 2018. In particular, the CEWC said the government will improve its supervision over local government debts. That being said, strategic projects related to government-led regional integration plans (such as the Guangdong “Bay area” blueprint, Xiong’an new district, and the Yangtze River Delta city-clusters) will still be supported by government budget spending and debt issuance.

(4)  Currency

The CEWC confirmed that China will maintain stability of the RMB exchange rate at a reasonable equilibrium level. Although the global financial market volatility and the interest rate hike of the Federal Reserve will weigh on the RMB exchange rate, the growth of Chinese economy and the ongoing RMB internationalization will offset the impact. We will expect two-way fluctuations of the RMB’s exchange rate in 2018

(5) Property

The CEWC repeated that the government will establish the “long-term price mechanism” for the property market, with “equal emphasis on rentals and sales.” It will encourage the professional and institutional participation in the rental market. We do not expect loosening of existing restrictions on purchase and resale to curb the property price. The development of private rental and public social housing may pick up. Going forward, the uncertainty on the property sector has somewhat increased.

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

The Passive Canon

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Jamie Farmer

Former Chief Commercial Officer

S&P Dow Jones Indices

A “canon” refers to the core texts that constitute the doctrine of a specific discipline.  Different faiths hold certain letters and books as canon.  The same can be said of a body of works that shaped and directed a culture.  The original Ghostbusters is, obviously, a canonic comic film and anyone who suggests otherwise should be met with scorn and opprobrium.

While presenting recently to some indexing neophytes, I referenced a few of the important academic works that are foundational in the development of passive investing.  Serendipitously, I discovered during my prep that the English word “canon” comes from the Greek “κανών”, which can be translated as “rule” or “measuring stick”.  And benchmarks and indices are, of course, the measuring sticks for investment performance.   How cool is that?

Here, therefore, are the works from my list.  Seven texts from The Passive Canon

“Portfolio Selection” by Harry Markowitz in The Journal of Finance (1952) – in this ground-breaking work, Markowitz introduces Modern Portfolio Theory (MPT).  He demonstrated that the risk/return profile of a portfolio is determined by combining the expected risk and return of its component securities and their relative correlations.  In doing so, he underscored the benefits of diversification – i.e. that a broad portfolio of holdings can offer greater risk-adjusted returns.

“The Performance of Mutual Funds in the period 1945-1964″ by Michael Jensen in The Journal of Finance (1965) – Jensen offered one of first studies that indicated active fund managers tend to underperform their benchmarks.  This is a forebear of S&P DJI’s SPIVA research, which for 15 years has been the de facto scorecard for the passive vs. active debate.

“Random Walks in Stock Market Prices” by Eugene F. Fama in Financial Analysts Journal (1965) – herein, Fama coined the term “efficient market”.  He conducted extensive research on stock price patterns and their unpredictability, positing that prices quickly incorporate available information.  The underlying notion of this “Efficient Markets Hypothesis” is that it is very difficult, if not impossible, to consistently identify individual securities that are mispriced relative to their intrinsic value.

“A Random Walk Down Wall Street” by Burton G. Malkiel (1973) – Malkiel drew attention to concept of an index fund when he complained that “Fund spokesmen are quick to point out you can’t buy the market averages.  It’s time the public could.”  Three years later, the first mass-marketed index fund was introduced.

“Challenge to judgment” by Paul Samuelson in The Journal of Portfolio Management (1974) – any article that John Bogle credits as his inspiration for the first index mutual fund must be canonical.   Samuelson contended there was insufficient evidence that money managers were skilled enough to produce consistent, market-beating returns.  He mused, “At the least, some large foundation should set up an in-house portfolio that tracks the S&P 500 Index — if only for the purpose of setting up a naive model against which their in-house gunslingers can measure their prowess.”  Shortly thereafter, Mr. Bogle picked up that gauntlet.

“The Loser’s Game” by Charles Ellis in Financial Analysts Journal (1975) – from the paper: “…most institutional investment managers continue to believe, or at least say they believe, that they can and soon will again “outperform the market.” They won’t and they can’t.”  Written 40 years ago, Ellis’s proclamation could have easily come from today’s news.  He points to a few reasons for this, chief among them that the markets are increasingly professional – active managers are trading against one another and both sides of that trade can’t be right.

“The Arithmetic of Active Management” by William Sharpe in Financial Analysts Journal (1991) – Sharpe lays out a clean, elegant construct that explains much of the underperformance of active:  1) Since passive investors own a pro-rata share of the market, active and passive investors in aggregate own the same portfolio; 2) Active management is inherently more expensive than passive management; 3) Therefore, “properly measured, the average actively-managed dollar must underperform the average passively-managed dollar, net of costs.”

Record-breaking passive asset flows are a very “now” phenomenon, but they’re properly evidence of an incremental advance rather than a seismic shift.  This sampling of works – four of which come from Nobel Prize winners (Markowitz, Fama, Sharpe and Samuelson) – are the incremental contributions that have made it possible.

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