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The S&P 500 Bond Index and… Mexico!

Quality and Diversification within the Preferred Stock Space

S&P 500 Posts Best January Since 1997

2017 Retirement Funding Update for DC Account Holders

Carbon Emissions History of the S&P 500® and its Sectors

The S&P 500 Bond Index and… Mexico!

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Jaime Merino

Director, Asset Owners Channel

S&P Dow Jones Indices

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When we talk about investments in the U. S., the first thing that comes to mind is the S&P 500®, since it is used to analyze and track large-cap stocks in the U.S. market. Following this iconic index, in July 2015 S&P DJI introduced the S&P 500 Bond Index, which is designed to be a corporate-bond counterpart to the S&P 500. Market value-weighted, the index seeks to measure the performance of U.S. corporate debt issued by constituents of the S&P 500. One of the uses of the S&P 500 Bond Index is to compare the equity and bond markets—some of these comparisons may include performance and sectors. Taking into account sectors, ratings, and maturities, the index has more than 150 subindices, and is calculated in several currencies. Can the index also be used to compare with indices outside of the U.S.? Let’s compare the performance and returns between the S&P 500 Bond Index and the S&P 500 Bond Index (MXN [returns expressed in Mexican pesos]), with four different Mexican indices, two sovereign bond indices and two corporate bond indices.

Exhibit 1 shows the performance over the past 10 years of the S&P 500 Bond Index, S&P/BMV Mexico Sovereign Bond Index (which tracks nominal fixed-rate bonds and bills), and the S&P/BMV Corporate Bond Index (which is designed to measure the performance of Mexican corporate-issued bonds). Then, in Exhibit 2, we can see the performance differences between the S&P 500 Bond Index (MXN), S&P/BMV Sovereign International UMS Bond Index, and the S&P/BMV Corporate Eurobonos Bond Index, both of which include the returns of the currency, since they track the eurobond market (bonds issued outside of Mexico in U.S. dollars), expressed in Mexican pesos.

With a yield-to-maturity average spread of more than 335 bps for the past three years, it is interesting how the first group behaved similarly (without taking into account the credit crisis in 2007-2008). The second group’s behavior was expected due to the currency; the correlations are shown in Exhibit 3.

Exhibit 4 shows the annual returns in different time frames, where we can see in more detail how similarly the corporate bond markets have behaved for issuers from the U.S. and Mexico—as measured by the S&P 500 Bond Index (MXN) and S&P/BMV Corporate Eurobonos Bond Index, respectively—with three-year returns of 16.00% and 16.56%, respectively, and five-year returns of 15.68% and 15.62%, respectively.

In times of volatility and when searching for yield, Mexico may provide a good portfolio diversification with the extra yield for those seeking it given the correlation between Mexico and U.S. corporate bonds, as well as with their 2017 performance.

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

Quality and Diversification within the Preferred Stock Space

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Derek Babb

Senior Portfolio Manager

Elkhorn Capital Group, LLC

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Preferred stocks are a class of stock that pays dividends at a specified rate and has a preference over common stock in the payment of dividends and the liquidation of assets. This asset class offers investors a unique place in the capital structure that is often overlooked. In addition, their relatively low correlations with traditional asset classes, such as common stocks and bonds, may provide potential portfolio-diversification and risk reduction benefits.

Credit Quality is Often Overlooked

While many investors are attracted to preferred stocks due to their high yields, credit quality can often be an overlooked aspect of a preferred portfolio. A broad preferred index, such as the S&P U.S. Preferred Stock Index, can leave investors overweight junk-rated preferred issues. Adding a high quality, 100% investment grade, sleeve such as the S&P U.S. High Quality Preferred Stock Index, into a preferred portfolio can improve portfolio credit quality which may mitigate the impact of a market sell off.

Sector Composition Matters

Given their market capitalization weighted structure, most broad preferred stock indices are significantly weighted towards the Financial sector. At the end of 2017, the S&P U.S. Preferred Stock index had a 73.2% allocation to Financials, followed by Real Estate at 12.0% and Health Care at 3.5%. The S&P U.S. High Quality Preferred Stock Index exhibited more diversity in its composition, as it finished 2017 with a 59.4% weight to Financials, followed by Real Estate at 18.1% and Utilities at 12.1%.

By adding exposure to the S&P U.S. High Quality Preferred Stock Index, investors may not only benefit from increased credit quality, but will also further diversify their sector and industry exposure.

As of December 29th, 2017, the S&P U.S. High Quality Preferred Stock Index exhibited an indicative yield of 5.09%. At the same time, the indicative yield of the S&P U.S. Preferred Stock Index was 6.11%. While the difference in yield between the two indices is over 1%, what investors are losing in yield, they are gaining in increased credit quality and diversification in the S&P U.S. High Quality Preferred Stock Index.

Jason Giordano, Director of Fixed Income Indices at S&P Dow Jones Indices, states in Fixed Income 101: U.S. Preferred Stock, that preferred stock is an effective portfolio construction tool given its low correlation to both common stocks and fixed income. He notes that an allocation to preferred securities may provide an opportunity for enhanced total returns while potentially reducing overall volatility. Before allocating, however, investors should consider the allocation impact to overall portfolio credit quality and sector diversification.

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

S&P 500 Posts Best January Since 1997

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Jodie Gunzberg

Managing Director, Head of U.S. Equities

S&P Dow Jones Indices

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If the glass can be more than half full, this stock market glass is so full, it’s time to wonder when it may spill over.  Large-caps continue to lead the U.S. equity market with the S&P 500 (TR)  delivering its 15th consecutively positive month, its best month since March 2016, its best January since 1997 and its eighth best January on record, gaining 5.7% (since 1971.)

Source: S&P Dow Jones Indices

In prior years with January gains this big, all the years ended highly positive with the exception of 1987, which arguably had a structurally different market than today.  While 1995 was the best year on record with a gain of 37.6%, its January that gained 2.6% was not quite as strong as in 2018.  However, the 2nd, 3rd and 4th best years are all on the list with other very high ranking years too.

Source: S&P Dow Jones Indices

The market is excited to say the least.  In a measure of optimism by the outperformance of the S&P 500 versus the S&P 500 Bond Index, the stocks are outperforming by the most, 6.6%, since October 2015, when the outperformance was 7.9%. Also, the consumer discretionary sector showed its greatest optimism with a premium of 10.1%, the 7th most in history, and the most since Sep. 2010, when its premium was 10.5%.  This is supported by the tax cuts and the increased consumer confidence of 125.4 (1985=100), up from 123.1 in December, as reported by the Conference Board.  Though the glass looked more than half full for the health care sector in January that posted its biggest premium since January 2013, that glass may be starting to empty from the push to cut health care costs.  It may not be the only sector starting to look half empty as real estate and utilities are both measuring discounts for the second consecutive month.  Though a few of these glasses are looking half empty most seem still very full. If the S&P 500 Bond Index starts outperforming its more famous stock counterpart, the S&P 500, it could be a warning sign.  Immediately following that high premium in October 2015, the stock market topped on Nov. 3, 2015, and by December investors saw the glass as half empty. The exuberant premium turned into a discount, and in the following period through Feb. 11, 2016, the market dropped 12.7%. 

Source: S&P Dow Jones Indices

In other segments of the U.S. equity market, the performance continued to be strong in January.  The S&P SmallCap 600 (TR) returned 2.5% and the S&P MidCap 400 (TR) gained 2.9%. While consumer discretionary led large caps, gaining 9.3%, its best month since Oct. 2011, health care led small-caps, gaining 11.1%, the most since Sep. 2010, and mid-caps, gaining 8.5%, its best month since Jan. 2012.  The large cap consumer discretionary sector may not be only benefiting from the tax cuts and high consumer confidence but from the international business boost from the weaker dollar.  In the health care sector, where so much business is domestic for smaller and mid cap companies the tax cuts may mean more for them, helping them outperform the larger part of their sectors.  Together with health care and consumer discretionary, financials, industrials, information technology and materials gained regardless of size.  Smaller consumer staple companies have been challenged with changing consumer tastes for food with higher demand for whole and raw ingredients. Mid-cap energy companies also underperformed the big and small parts of the sector as they may not have been able to benefit as much from international business as the large caps but may have also been more hedged and less nimble than small caps as oil rebounded and the dollar fell. Real estate and utilities are suffering from falling bond prices and rising yields from more inflation fears after the passage of the tax cuts.  Large-caps are outperforming mid-caps by 2.9%, the most since Sep. 2014 and are outperforming small caps by 3.2%, the most since May 2017.

Source: S&P Dow Jones Indices

The weaker dollar seems to be winning over the tax cuts in lifting large caps beyond the mid and small size companies, though on average the falling dollar helps mid-caps most. Energy and materials gain most from a falling dollar since the natural resources are priced in dollars.  Although large-caps do most international business, the falling dollar may present growth opportunities for mid-caps that otherwise might not do as much international business.  If the dollar continues to fall, energy, materials, information technology, industrials and consumer discretionary may be where to overweight, as well as in mid-caps and growth.

Source: S&P Dow Jones Indices and Bloomberg DXY

 

 

 

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

2017 Retirement Funding Update for DC Account Holders

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Philip Murphy

Managing Director, Global Head of Index Governance

S&P Dow Jones Indices

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2017 was generally kind to U.S. shareholders of domestic and international equities, but long-term U.S. Treasury Inflation-Protected Securities (TIPS) rates drifted downward, increasing the present value of future inflation-adjusted cash flows discounted to the TIPS curve. An important question for retirement savers may be whether investment returns outpaced the increased cost of securing future in-retirement income.

Exhibit 1 shows the change in present value in 2017 of 25-year inflation-adjusted cash flows, commencing in each of the respective years on the horizontal axis. Discount rates used to calculate pricing are derived from the TIPS yield curve. As expected, the chart illustrates that for a given change in rates, the longer duration cash flows experience more of a price change. Retirement savers planning to retire around 2030, for example, saw the cost of providing themselves 25 years of inflation-adjusted income increase by 7.5%. Other income sources, such as insurance company annuities, would generally move in the same direction but by varying magnitudes, depending on a number of external factors, like the insurance company profit margin and various features of specific annuity contracts. Nevertheless, tracking income cost by this straightforward method is a reasonable proxy for the cost of future income, and S&P DJI provides this metric monthly as part of its S&P STRIDE Index Series offering.

Exhibit 2 shows the 2017 total returns of U.S. stocks and bonds, as measured by the S&P 500®, the S&P U.S. Aggregate Bond Index, and a hypothetical 60/40 mix of the two.

For each of the benchmarks in Exhibit 2, Exhibit 3 shows the excess total return of the respective benchmark over the increase of the cost of income for each respective year (from 2020 to 2060). A couple of observations stand out in Exhibit 3. For all of the target years from 2020 to 2060, U.S. equities outpaced the rise in cost of future income. Of course, the volatility of equities means that from year to year this will not always be the case, but 2017 was kind to shareholders.

On the other hand, the broad U.S. bond market, as measured by the S&P U.S. Aggregate Bond Index, while returning a respectable 3.3%, failed to keep pace with the rise in cost of future income for any respective target years. Those only a few years from retirement with a higher exposure to bonds, and particularly short-term bonds, would find that their portfolio did not keep pace with the cost of income.

Lastly, the 60/40 stock/bond mix held up fairly well for most of the target years, but particularly well for those cohorts approaching retirement first. The years 2020 to 2035 all saw excess returns from a 60/40 mix of at least 5%. However for 2055 and 2060, there was not enough equity risk in the 60/40 mix to keep pace with the significant rise in cost of income commencing in those respective years.

Finally, Exhibit 4 is similar to Exhibit 3, but it shows the excess total return of specific S&P STRIDE Indices over the rise in cost of future income.

Like the S&P 500, the S&P STRIDE Indices outpaced the rise in cost of future income for all target years from 2020 to 2060. However, unlike the S&P 500, excess returns for all target years (including 2060) were greater than 5%. In addition, the range of excess returns across target years was significantly tighter than it was for the S&P 500, the S&P U.S. Aggregate Bond Index, or a 60/40 mix of the two.

As a result of the S&P STRIDE Index Series methodology, the index weight of near-dated S&P STRIDE Indices are heavily allocated to a mix of U.S. TIPS matching the duration of retirement income for the respective target year. For example, as of December 2016, the weight allocated to U.S.TIPS in the S&P STRIDE Glide Path 2020 Index Total Return was 65.7%. In spite of having significant fixed income within the index, excess return over change in cost of income was substantially positive (unlike the comparison using the S&P U.S. Aggregate Bond Index). 2017 showed that the strategy underlying the S&P STRIDE Indices met its design objective of generally offsetting changes in the cost of future income. Retirement savers should take note that managing portfolios to mitigate future income risk may make the transition from work to retirement a lot smoother.

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

Carbon Emissions History of the S&P 500® and its Sectors

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Kelly Tang

Director

Global Research & Design

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Every year, Trucost and GreenBiz Group release their annual State of Green Business report, which gives an overview on the state of the sustainability movement and reviews 30 key indicators assessing corporate sustainability performance. As noted by Richard Mattison, CEO of Trucost, in a blog from earlier this month, the carbon emissions of the largest global companies have decreased in absolute terms and are at the lowest level in the past five years due to increased use of cleaner fuels. In this blog, we analyze the carbon emissions for the S&P 500 companies to gain insight about the index’s carbon emission history and understand which sectors are driving this downward shift.

Emissions are typically measured by mass of carbon dioxide equivalent (CO2e), whereby the “equivalent” is a proxy applied to greenhouse gases other than carbon dioxide and reflects their relative environmental impact. The units of reference are in kilotons of CO2e.[1] Exhibit 1 shows the total direct emissions (operational and first-tier supply chain greenhouse gas emissions) for the S&P 500 on an annual basis from December 2009 through December 2017, and 2017 (in yellow) comes in as the lowest absolute emissions figure in the nine-year period for which historical data is available.

In terms of sectoral contributions, the utilities and energy sectors have consistently represented the top two sectors generating the largest amount of greenhouse gas emissions, with utilities contributing 50% and energy approximately 20%, totaling to 70% for 2017. This amount represents an improvement from 2009 when these two sectors combined represented 83% of carbon emissions (see Exhibits 2 and 3).

Exhibit 4 compares the percent change from 2009 to 2017 for the S&P 500 and its GICS sectors for direct carbon emissions. Carbon emissions fell 11% for the overall index in the past eight years, with the highest emitting sector (utilities) decreasing its total direct emissions by 29%. The energy sector has also shown an emissions drop of 13% in the same time frame.

Analyzing the carbon emissions change data highlights sectors that show the greatest improvement and interestingly enough, the greatest reductions stem from the highest emitting sectors. As we mentioned in the previous “Evolution of Carbon Awareness Investing” blog, previous iterations for index construction had incorporated exclusionary screening, whereby the highest carbon emission offenders, whether on an absolute basis or a sector-neutral method, are excluded. However, as shown by the carbon momentum data in Exhibit 4, if the intent is to motivate carbon reductions, then the exclusionary option may not be the best choice and employing carbon momentum data may be more viable as it rewards companies that are working to reduce emissions.

The shift to renewables and cleaner technology is taking place, albeit at a slower pace than what is needed to meet the 2 degree targets as stipulated in the Paris Agreement. For institutional asset owners who can meaningfully influence a corporation’s behavior, one way to speed up carbon emissions improvement and percent change may be to consider redirecting capital to those companies that exhibit positive carbon momentum.

[1]   Emissions data is sourced from Trucost, which provides data on both direct and first-tier indirect emissions on a company-by-company basis; if companies do not report or otherwise make such figures available, Trucost estimates the emissions of each company using a proprietary model. Direct emissions, as the name suggests, encompasses emissions of CO2e produced directly by the entity, whereas indirect emissions are those that arise from the entity’s suppliers of materials and equipment, utilities such as electricity and business travel. The inclusion of indirect emissions is not always preferable, especially in an index, as this may result in double counting. For example, if a utility company as well as one of its customers is included in the same index, the emissions of the latter would be counted twice.

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