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Capturing Global Market Gains Using U.S. Sectors

Investing in a World of Unknown Future Outcomes: The Benefits of Equal Weighting

Quality over quantity: China’s Economic Growth Focus in 2018 – Part 2

Factor Investing 101

Could Tax Reform Benefit Consumer Spending?

Capturing Global Market Gains Using U.S. Sectors

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Jodie Gunzberg

Former Managing Director, Head of U.S. Equities

S&P Dow Jones Indices

Almost a decade after the global financial crisis, the S&P Global BMI (Broad Market Index), a measure of the global stock market has gained 234.4% from its bottom on March 9, 2009.  As of January 26, 2018, the index level was 33.7% above its pre-crisis high that happened on October 31, 2007.  Interestingly, the current return over the pre-crisis high matches almost exactly the gain of 34.2% since President Trump’s inauguration.

Source: S&P Dow Jones Indices

Coincidence or not, the booming stock market seems to be supported by several data points, especially from the U.S. including the $1.5 trillion tax cut, higher consumer confidence, higher consumer spending, low savings and increased government spending.  What happens in the U.S. and to its stock market is vital to the rest of the world, since U.S. growth requires imports of parts and components from foreign manufacturers, and the U.S. makes up over half the world’s market capitalization of $58.6 trillion.

Source: S&P Dow Jones Indices

Not only is the U.S. the biggest market in the world but it has led the major countries in performance of the recovery since the global financial crisis and in surpassing the pre-crisis top. However, China, South Korea, Germany, France and emerging markets in general are outpacing the U.S. since President Trump’s inauguration.

Source: S&P Dow Jones Indices

This may be since the U.S. GDP growth drives up every major stock market in the world, but helps stock market performance in some countries more than others, and even more than in the U.S. itself.  South Korea, China, Switzerland, Germany and emerging markets overall benefit most from U.S. GDP growth, while Japan, the U.K. and other developed international markets are less sensitive.  For example, while the U.S. stock market rises on average 3.8 percent for every one percent of U.S. GDP growth, the Korean stocks rise 9.4 percent on average and Japan’s stock market rises just 2 percent.

Source: S&P Dow Jones Indices

The disparity gives opportunity to market participants investing around the world to select countries or regions based on U.S. growth expectations.  However, not all investors participate in global stock markets or choose exposure by country, and may fully or partially rely on U.S. equities for their “global” stock market exposure.

Examining the sector weights of the S&P 500 by global revenue rather than only of the market capitalization can help quantify where exposure is in the world despite a U.S. listing.  When weighted by foreign revenues or U.S. revenues rather than market capitalization, the sector makeup of the U.S. stock market represented by the S&P 500 changes significantly.  Information technology has far more foreign revenue exposure than financials but financials have much higher U.S. revenue exposure.  The information technology weight increases from 24 percent of the S&P 500 to 41 percent of the foreign revenue exposure index, but drops to just 3 percent of weight in the U.S. revenues exposure index.  On the other hand, the financial sector drops 8.5 percent of weight in the foreign revenue universe but is the biggest sector of the U.S. revenue exposure index at 27 percent. Other sectors with notably more foreign revenue exposures are materials and energy, while consumer discretionary, real estate, telecommunications and utilities make up proportionally more of U.S. revenue exposures.

Source: S&P Dow Jones Indices

The sector weights by global revenue exposure combined with the S&P 500 up market capture ratios can give a better understanding of how return is generated from U.S. GDP growth.  For example, the real estate sector has returned on average 6 percent for every one percent of GDP growth but has very little foreign revenue exposure, so may be a strong sector to overweight for both diversification to international equity exposure and for upside potential with U.S. economic growth.  On the other hand, the materials sector has comparatively low upside capture, gaining about 3 percent on average for every one percent of U.S. GDP growth, combined with relatively high correlation to most international markets, making it a possibly less desirable choice for growth and diversification internationally, but can give strong international exposure.  The industrials sector has a higher upside market capture ratio to U.S. GDP growth and more correlation to international markets, so might be a better choice for growth and international exposure.

Source: S&P Dow Jones Indices

If applying U.S. equities to get international exposure is a main goal, large-cap companies do the most global business.  However, if the main goal is to get the most upside from U.S. GDP growth, and rotation between market capitalization sizes is a possibility, small-caps may be the best bet.  Large-caps outperformed small-caps by the most in 2017 since 1999, but large-cap performance that big typically doesn’t last, especially when quality is a factor in a small-cap index like the S&P 600 indexThe upside market capture ratio of the S&P 600 to U.S. GDP growth is near 515 versus just 400 for the S&P 500, giving an extra 115 basis points of return on average for every one percent of U.S. GDP growth.  Within the small-cap space the sectors that benefit more are financials, health care and energy, but of course need to be reviewed with other factors like interest rates, inflation, the dollar and oil prices taken into consideration.

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

Investing in a World of Unknown Future Outcomes: The Benefits of Equal Weighting

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Anu Ganti

Senior Director, Index Investment Strategy

S&P Dow Jones Indices

Consider this thought experiment: You “know” that 499 of the companies in the S&P 500® will return exactly 5% next year. One will return 100%. You have no way to determine which stock will be the big winner, or to know or infer anything about its characteristics. You can invest in either a cap-weighted S&P 500 index fund, or an equal-weighted S&P 500 index fund. What should you do?

We can begin by noticing that 120 of the 500 issuers in the S&P 500 are weighted at more than 0.20%—i.e., they have a higher weight in the cap-weighted index than in its equal-weighted counterpart. 380 issuers are weighted more heavily in equal-weight. We face a binomial choice—either equal-weight or cap-weight—and the “success” of that choice will be determined entirely by which index has a relatively higher weight in the one stock that’s up 100%. Since we are completely agnostic about the stock in question, choosing the equal-weighted index gives us a 76% probability of success.

Our example, of course, is artificial for any number of reasons, but it does illustrate an important truth: positively skewed returns favor equal-weight indices. Anyone who’s read a prospectus knows that past performance is no guarantee of future results. But past performance has indeed taught us two key lessons:

  • Historical gains in equity markets have been driven by a relatively small number of stocks.
  • The identity of these stocks is unknown—and generally unknowable—in advance.

The first point—the skewness of market returns—is clear in historical data. In 23 out of the past 27 years, the median stock in the S&P 500 has underperformed the return of the average stock. We see similar results in other markets. And if the second point were not true, we would not observe consistent underperformance from active managers.

These two points help us to understand a third:

To be sure, equal weighting does not always lead to success. For example, 2017 was an outlier, as the S&P 500, driven by a handful of large technology stocks, outperformed the S&P 500 Equal Weight. But the equal-weighted index has outperformed in 16 of the past 28 years, by an average margin of 1.5% annually. One reason for this record is the ability of equal-weight indices to take advantage of the positive skew in stock market returns.

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

Quality over quantity: China’s Economic Growth Focus in 2018 – Part 2

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Jack Jiang

Senior ETF Specialist, Index and Quantitative Investment

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

After the Central Economic Work Conference (CEWC), specific plans and targets have been set for China’s economy. What are the investment opportunities followed the CEWC?

Investment outlook

To achieve high-quality development, the government will promote consumption and private investment to drive growth. Rural reform targeting to alleviate the poverty such as restoring land use rights to farmers could also unlock rural land wealth of US$20trn and hence boost rural consumption.

The government has recently selected 31 central and local SOEs as the third batch of the mixed ownership reform pilots program. SOE reforms, especially SASAC (State-owned Assets Supervision and Administration Commission of the State Council) reform, will accelerate in 2018.

New energy and eco-friendly firms will gain from anti-pollution initiatives. “China going green” is a government-led initiative for investment in the medium term. Investment in rural infrastructures (roads, access to water, power and Internet, etc.) and industries will likely emerge as a new growing area of fixed asset investment.

S&P China 500 Index consists of 500 largest and most liquid Chinese companies listed globally. It covers almost all the potential China-related investment opportunities. Broad based strength in Chinese equities propelled the S&P China 500 to a 44% total return for the year of 2017. The index had notably consistent performance during the year as well recording positive returns in all 12 months.

Benefited from its diversification in markets and sectors exposure, S&P China 500 has demonstrated better risk-adjusted returns (Figure 2). During the period from 31 Dec, 2008 to 31 Dec, 2017, the S&P China 500 generated an annualized return of 13.0% and Sharpe ratio of 0.59, both are the highest among the major China indices.

1  ChinaDaily, 21 Dec 2017.

2  ChinaDaily, 20 Dec 2017.

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

Factor Investing 101

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Akash Jain

Associate Director, Global Research & Design

S&P BSE Indices

For many years, active fund managers and institutional investors have often used a factor-based approach either to strategically construct portfolios or to tilt their portfolios toward well-known risk factors, such as low volatility, value, momentum, dividend, size, and quality, to capture the factor risk premium. Investors seeking to identify skilled active managers look to dissect fund performance into returns generated from factor exposures and alpha that is attributable to fund manager skill, which in turn should affect fund flows.[1]

An analogy[2] used to explain this concept associates factors to nutrients and stock returns to food items. Different food items (such as pulses, milk, vegetables, bread, burgers, pizza, etc.) contain nutrients (such as carbs, vitamins, proteins, fats, minerals, etc.) in varying proportions. Similarly, a stock’s risk/return characteristics can be thought of as being explained by different risk factors. A factor index looks to bucket stocks with similar risk/return characteristics. Extending this analogy, different individuals (e.g., an athlete versus someone with a desk job) have different nutrient requirements, therefore they would consume different combinations of food items. Similarly, investors with different risk appetites would allocate accordingly to different factors to generate returns. For example, an investor who is keen on a low risk or defensive portfolio would potentially look to allocate a higher proportion to low volatility and quality factors, whereas as an aggressive investor might look to add exposure to value and size (small-cap) factors. Factor-based investing provides a route to objectively capture inexpensive companies (via value factors) or companies with robust balance sheets and steady returns on equity (via quality factors).

The first model that initiated the conversation on factor investing was the Capital Asset Pricing Model (CAPM) suggesting that a single factor—market exposure—drives the risk and return of a stock. The CAPM suggested that returns that were unexplained by the market factor were idiosyncratic or company-specific drivers. Gradually, the Fama-French Model looked to account for additional factors such as size and value, in addition to broad market returns. Follow-up research by Carhart and Pastor-Stambaugh yielded two new factors, viz momentum and liquidity, respectively. As academic research evolved, newer factors, such as growth, quality, dividends, and volatility, were thought to have attributed to stock returns as well.

Exhibit 1: The Evolution of Factor-Based Investing

Source: Fidelity Investments.[3] Chart is provided for illustrative purposes.

Factor-based investing can be implemented passively with the aid of factor indices aiming to provide exposure to specific factors, following rules-based methodologies, which tend to be more cost effective and transparent than actively managed portfolios. Globally, smart beta products have gained tremendous popularity with smart beta equity ETF/ETP assets, seeing an AUM growth of over 31% CAGR to USD 644.40 billion for the five-year period ending in September 2017. Smart beta ETFs/ETPs account for almost 19% of all equity ETF/ETP AUM as of September 2017.

Exhibit 2: Market Cap Beta Versus Smart Beta

Source: ETFGI.[4] Chart is provided for illustrative purposes.

Factor indices are not designed to replace market-cap-weighted indices. Broad-based or market-cap-weighted indices represent the entire investable opportunity set for market participants. They aim to capture long-term equity risk premium with low portfolio turnover, high trading liquidity, and large investment capacity. Factor indices look to capture targeted risk premia following a rules-based and transparent index methodology. Not only is the stock selection for these indices based on specific factor criterion, but the stock weights are also related to the stocks’ factor scores, which are used to create factor tilts within the index portfolios. In contrast to passive products based on broad-based indices, factor-based strategies can provide an opportunity for market participants to express their active views away from market-cap-based portfolios. Thus, like active funds, factor performance should be evaluated in the long run against a market-capitalization-weighted benchmark.

Please refer to Factor Performance Across Different Macroeconomic Regimes in India for more information on this research paper.

[1]   Barber, B., Huang, X. and Odean, T. (2017). What Risk Factors Matter to Investors? Evidence from Mutual Fund Flows.




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

Could Tax Reform Benefit Consumer Spending?

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Nick Kalivas

Senior Equity Product Strategist


Investment strategies featuring the quality factor could benefit from current trends in consumer spending

  • Retail sales surged by more than 5% in December, eclipsing previous highs.
  • Consumer spending could be further bolstered by recently enacted federal tax cuts.
  • Investment strategies that include the quality factor could benefit from higher consumer spending.

Advance estimates of US retail sales for December 2017 displayed vibrant year-over-year growth of 5.64%, according to the US Census Bureau.1 The most recent report, released on Jan. 12, covers sales ex-food, automobiles, gasoline and building materials. December sales growth was at its highest level since peaks in 2011 and 2014, and was above the trend seen since early 2011 — further highlighting strength in consumer activity.

Federal tax reform could benefit consumer spending

Looking forward, I believe that strength in consumer spending is likely to be underpinned by the recently passed federal tax cut, dubbed the Tax Cut and Jobs Act. (Harsh winter weather may be a caveat, however.) In fact, a number of companies have already announced employee bonuses and higher wages in the wake of this legislation.

Robust consumer spending is typically a friendly factor for the equity market, and may provide a reason to maintain equity exposure, in my view, despite high equity valuations seen over the past year and the lack of any significant market correction. On a total return basis, the S&P 500 Index closed higher in every month of 2017, while its forward price-to-earnings (P/E) ratio is at 18.6 — a level last seen in the technology bubble of the early 2000s.2

Quality factor exposure can potentially harness strength in consumer spending

Investors who want to gain exposure to high-quality companies that can benefit from higher consumer spending may want to consider the quality factor. Consider, for example, that the S&P 500 Quality Index has 27% exposure to the consumer-focused sectors, with 12% of its holdings in consumer discretionary shares and 15% in consumer staples.2 Although the consumer staples sector can at times be viewed as defensive, this isn’t always the case. Consumer staples holdings within the S&P 500 Quality Index include Costco and Walmart, which are both influenced by consumer spending.

Other key exposures rest in industrials (23.5%) and information technology (22.5%).2 These two sectors have the ability to benefit from strong economic trends as well. Moreover, within information technology, the S&P 500 Quality Index holds Visa and MasterCard, with just over a combined 9.0% exposure.2 Both of these companies can benefit from strong consumer spending via their transaction-based businesses, which facilitate consumer purchases.

One of the potential benefits of the quality factor is the selection of stocks that have strong balance sheets. In this case, the S&P 500 Quality Index selects stocks based on return on equity, leverage and earnings quality via accruals.

1 Source: The US Census Bureau, Jan. 12, 2018

2 Source: Bloomberg L.P., as of Jan. 15, 2018


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