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How Do Single Factors Perform in Different Market Regimes in India?

With all the News of Higher Interest Rates, Don’t Forget About Floating-Rate Debt

How Global Is the S&P 500?

S&P BSE SENSEX During Budget Sessions Under Mr. Narendra Modi’s Rule

3 Reasons To Love Equities When Rates Are Rising

How Do Single Factors Perform in Different Market Regimes in India?

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Akash Jain

Associate Director, Global Research & Design

S&P BSE Indices

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In continuation to our previous blog titled “Factor Investing 101,” this blog investigates the performance of single factor indices in the Indian equity market. Over the period from October 2005 to June 2017, portfolios for all risk factors we examined—low volatility, momentum, value, quality, dividend, and size (small cap)—outperformed the S&P BSE LargeMidCap (see Appendix A for methodology of factor portfolios). However, only low volatility, quality, and momentum delivered better risk-adjusted return (return per unit of risk) than the S&P BSE LargeMidCap. Among the six factors, low volatility and quality recorded lower return volatility than the benchmark and had the highest risk-adjusted return, while value, dividend, and size displayed much more volatile return than the benchmark (see Exhibit 1).

Macroeconomic and market events affected each factor portfolio in different ways. Factor returns tended to exhibit cyclicality with periods of outperformance and underperformance in different phases of the cycles. In our report, we also examined how various risk factors performed in the Indian equity market across different macroeconomic regimes between October 2005 and June 2017.

Based on our factor performance analysis across business cycles,[1] we observed that value, dividend, and size exhibited strong pro-cyclical characteristics and tended to outperform the benchmark when business activities expanded. In contrast, low volatility, quality, and momentum outperformed the benchmark in both cycle phases but with a higher tendency to outperform the benchmark during business cycle contraction (see Exhibit 2). 

Apart from business cycles, factors also displayed different cyclical behavior across market cycles[2] that we divided into bearish, recovery, and bullish phases based on historical price trends of the S&P BSE SENSEX. Quality and low volatility tended to perform the best in bearish markets. Conversely, value, dividend, and size gained the highest excess returns when the market recovered from equity market troughs. In bullish markets, momentum had the strongest performance among all factors see Exhibit 3).

In addition, we also studied factor performance over investor sentiment regimes, which changed more frequently than market and business cycle phases. We used the rolling 22-day realized return volatility of the S&P BSE SENSEX Price Return as a proxy to measure investor sentiment in the Indian equity market. We divided the examined period into three sentiment regimes: bullish, neutral, and bearish. Bearish investor sentiment is signaled by high levels of realized volatility (values in the bottom decile), whereas bullish investor sentiment is represented by low realized volatility values (values in the top decile), and neutral investor sentiment makes up the periods when the realized volatility values lie between the top and bottom deciles. When market participants were bullish, results showed that value delivered the most excess return, while low volatility had the worst performance. In contrast, momentum and size underperformed, and high-quality stocks were favored by market participants when they were bearish. 

Appendix A: Overview of the S&P BSE Single-Factor Indices and Hypothetical Portfolios
FACTOR INDEX DESCRIPTION
Low Volatility S&P BSE Low Volatility Index The 30 least volatile companies from the S&P BSE LargeMidCap, weighted by inverse proportion to their volatility and subject to a stock capping of 5%.  Volatility is defined as the standard deviation of a security’s daily price return over the one-year period.
Momentum S&P BSE Momentum Index The 30 companies from the S&P BSE LargeMidCap with the highest momentum scores.  Constituents are weighted by the product of momentum score and float-adjusted market capitalization (FMC) and subject to stock capping of a minimum of 5% or three times the FMC weight in the eligible index universe.  Momentum score is computed as 12-month price change, excluding the most recent month, divided by standard deviation of price return for the same period.
Value S&P BSE Enhanced Value Index The 30 companies from the S&P BSE LargeMidCap with the highest value scores, weighted by the product of value score and FMC and subject to sector capping of 30% and stock capping of a minimum of 5% or 20 times the FMC weight in the eligible index universe.  Value score is calculated based on book-to-price, earnings-to-price, and sales-to-price ratios.
Quality S&P BSE Quality Index The 30 companies from the S&P BSE LargeMidCap with the highest quality scores, weighted by the product of quality score and FMC and subject to sector capping of 30% and stock capping of a minimum of 5% or 20 times the FMC weight in the eligible index universe.  Quality score is calculated based on return on equity, accruals ratio, and financial leverage ratio.
Dividend[3] S&P BSE Dividend Portfolio The 30 companies from S&P BSE LargeMidCap with the highest dividend yield, weighted in relative proportions to their dividend yields subject to sector capping of 30% and stock capping of 5%.
Size S&P BSE Equal-Weighted Portfolio All constituents from S&P BSE LargeMidCap weighted equally constitute the portfolio.

Source: S&P Dow Jones Indices LLC. The S&P BSE Dividend Portfolio and S&P BSE Equal-Weighted Portfolio are hypothetical portfolios. Data as of October 2017. Table is provided for illustrative purposes.

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

[1]   A business cycle is defined by the monthly movement of the Organisation for Economic Co-operation and Development (OECD) Composite Leading Indicator (CLI) for India. A rising CLI signals business cycle expansion and a falling CLI signals business cycle contraction (see Appendix A in report for the OECD Composite Indicator business cycles).

[2]   A bearish phase is defined as a period during which the S&P BSE SENSEX goes from peak to trough.  A recovery phase is defined as the 12-month period after the S&P BSE SENSEX trough.  A bullish phase is defined as a period from the end of the recovery phase to the next S&P BSE SENSEX peak (see Appendix B in report for Illustrative Market Cycles).

[3]   The eligibility criteria for the dividend portfolio require that each eligible stock maintains a ratio of dividend-per-share to par value-per-share above 10% for two consecutive years.

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

With all the News of Higher Interest Rates, Don’t Forget About Floating-Rate Debt

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Kevin Horan

Director, Fixed Income Indices

S&P Dow Jones Indices

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The story line for a number of years now has been the “search for yield” and how the recent low-interest-rate environment has been forcing investors down in credit or out the maturity curve in an effort to maintain income though adding risk. Now that interest rates have begun reversing the low-rate environment, fixed-coupon securities may experience downward price pressure to varying degrees depending on the terms of each bond. But for floating-rate securities, the story could be different. As rates have started to increase, income investors are getting the opportunity to earn higher returns on their investments when considering their options.

The U.S. Treasury began issuing floating rate notes (FRNs) in January 2014. To date, these notes have been issued for a term of two years. The FRNs pay varying amounts of interest quarterly until maturity. Interest payments rise and fall based on discount rates in auctions of 13-week Treasury bills. The S&P U.S. Treasury Bond Floating Rate Index and the S&P U.S. Treasury Bond Floating Rate Current 2-Year Index seek to measure the performance of current and previously issued U.S. Treasury floating-rate issuance representing the U.S. Treasury floating-rate market or the most recent 2-year issuance.

Exhibit 1 shows how the yield of these indices had been relatively flat since their inception, which starts with the U.S. Treasury’s inaugural issuance. From October, 2015 to Feb. 13, 2018, the index yields increased from 0.09% and 0.13%, respectively, to their current levels of 1.55% and 1.58%, respectively.

Total rate of returns, of floating-rate indices, have outperformed the similar duration  S&P U.S. Treasury Bill 3-6 Month Index, which has returned 0.01% for the month and 0.13% YTD as of Feb. 13, 2018 (see Exhibit 2).
Exhibit 1: Historic Yield-to-Worst

Source: S&P Dow Jones Indices, LLC. Data as of Feb. 13, 2018. Past performance is no guarantee of future results. Chart is provided for illustrative purposes.

 

Exhibit 2: Total Rate of Returns

Source: S&P Dow Jones Indices, LLC. Data as of Feb. 13, 2018. Past performance is no guarantee of future results. Chart is provided for illustrative purposes.

As anticipation continues for future rate hikes, FRN performance could further benefit from the interest rate changes. There are strategies designed to meet the needs of those looking to gain income as rates rise.

 

 

 

 

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

How Global Is the S&P 500?

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Phillip Brzenk

Senior Director, Strategy Indices

S&P Dow Jones Indices

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The S&P 500® is widely considered one of the best single gauges of the U.S. equity market. Composed of 500 companies that are domiciled in the U.S., the index captures approximately 82%[1] of the total U.S. equity market value. An index of U.S. companies may lead one to assume that the index is only reliant on the health and growth of the U.S. economy. In reality, the index is much more global than that. Many U.S. corporations have a global presence, with assets and revenues in foreign markets. Therefore, global market events and economic shocks can have a material effect on S&P 500 companies, thus overall index performance.

To better understand where S&P 500 companies’ revenues are coming from, we used the FactSet Geographic Revenue Exposure (GeoRevTM) dataset,[2] which gives a geographic breakdown of revenues for all companies with available data, down to the country level. Since there are no standardization rules for the reporting of geographic revenue segments, the dataset uses a normalization/estimation process to assign revenues to specific countries. The ability to have detail of revenues at the country level is an important tool in understanding potential country exposures or risks for a company or index.

We first look at total revenues at the regional level (see Exhibit 1). The Americas region, which combines the North and South American continents, is unsurprisingly the largest regional exposure, at 76% of total revenues. The Asia Pacific region (11.1%) and Europe (10.6%) follow in terms of total revenue, with Africa & Middle East having the lowest total revenues, at 2.4%.

At the country level, nearly 71% of S&P 500 revenues comes from the U.S., with the remaining coming from foreign markets. Internationally, the largest individual countries by total revenue include China (4.3%), Japan (2.6%), and the UK (2.5%).

Given the diverse mix of countries, it is important to examine the potential foreign currency exposure of the S&P 500, which we determined by mapping the currency used in each country (see Exhibit 3). Several additional observations can be made from the currency-based revenue chart. First, it shows that the euro is the foreign currency the S&P 500 has the most exposure to, coming in at 6%. Second, the chart shows the number and the mix of currencies the S&P 500 has exposure to—six foreign currencies with a total exposure of 1% or more and 19 currencies coming in at a minimum of 0.25%.

Given the results, we can see that the S&P 500 has meaningful exposure to foreign markets. As such, events both domestic and globally, as well as policies that change the dynamic between the U.S. and other foreign markets, can potentially have an effect on the S&P 500. In future posts, we will look at how the global market exposure of companies in the S&P 500 affect the performance of the index.

[1]   Source: S&P Dow Jones Indices LLC. Calculation as of Dec. 29, 2017.

[2]   More information on the dataset can be found here: https://www.factset.com/data/company_data/geo_revenue

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

S&P BSE SENSEX During Budget Sessions Under Mr. Narendra Modi’s Rule

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Ved Malla

Associate Director, Client Coverage

S&P Dow Jones Indices

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On May 16, 2014, the Lok Sabha election results were announced and Mr. Narendra Modi’s Bharatiya Janata Party got a clear mandate to form the government. Narendra Modi was sworn in as the Prime Minister of India on May 26, 2014. Since taking charge, the Narendra Modi government has made several landmark policy decisions. Some of these initiatives are listed below.

  1. GST: The Goods and Services Tax is the biggest tax reform since Indian independence.
  2. Aadhaar Linking: Linking Aadhaar to bank accounts, PAN Card, mobile number, etc.
  3. Jan-Dhan Yojana: Aimed at bringing banking services to every household in India.
  4. EPFO Investment in ETFs: Employees’ Provident Fund permitted to invest in ETFs.
  5. Demonetization: Aimed at cracking down on black money.
  6. Digital India: Aimed at digitizing India and moving to cashless transactions.
  7. Make in India: Aimed at making India a global manufacturing hub.
  8. Skill India: Aimed at providing skill development training to youth.
  9. Startup India: Aimed at promoting entrepreneurship.

The S&P BSE SENSEX is the oldest and most-tracked index in India, and it acts as an indicator of India’s economic growth. Any national or international change in economic activity is likely to have an impact on the S&P BSE SENSEX.

The S&P BSE SENSEX’s total return index value increased from 27,648.13 on Jan. 31, 2014, to 51,281.74 on Jan. 31, 2018, and the highest close was at 51,729.13 on Jan. 29, 2018. This represents a four-year CAGR of 16.70% for the period.

Every year, the Finance Minister presents the Union Budget, which is perhaps the most important economic activity in India. “Budget Day” comes with a lot of expectations, and it therefore has a bearing on the capital markets in both the pre- and post-budget sessions. Mr. Arun Jaitley has been the Finance Minister since this Government was formed. Arun Jaitley has presented four budgets during this term and will be presenting his fifth budget on Feb. 1, 2018.

In Exhibit 2, we can see that in most years, the S&P BSE SENSEX witnessed high volatility in the 30-day pre- and post-budget sessions. The highest 30-day pre- and post-budget volatility was observed in the budget year 2016. The lowest volatility in the 30-day pre-budget session was seen in 2018.

To conclude, we can say that the budget sessions are usually volatile for capital markets in India. The pre-budget movement is caused by market participant expectations for the budget, while the post-budget movement is based on the actual budget presented by the Finance Minister. The budget may be the most important economic activity affecting capital markets in India, and its relevance is captured in the movement of S&P BSE SENSEX.

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

3 Reasons To Love Equities When Rates Are Rising

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Jodie Gunzberg

Managing Director, Head of U.S. Equities

S&P Dow Jones Indices

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Equities haven’t been the most lovable asset class lately but there are reasons to love them despite these prickly times.  The first reason to love equities in rising rate times is that they have gained significantly. Since 1971, the S&P 500 (TR) has gained about 20% on average in rising rate periods, has gained 8 of 9 times and has gained nearly 40% twice with less than a 4% loss for its worst rising rate period. Source: S&P Dow Jones Indices and Federal Reserve Economic Data, Economic Research Division, Federal Reserve Bank of St. Louis. https://fred.stlouisfed.org

While this is less upside than equities have enjoyed in falling rate environments, and some of the equity duration models result in falling asset prices as the discount rate rises, the reality is results can vary.  This is since the equity duration is based on a derivative of the dividend discount model that uses long term interest rates plus an equity risk premium, but these models also rely on growth and inflation.

If there is accelerating growth and inflation, like now, rising interest rates can result in appreciating assets, which is the second reason to love equities in this rising rate time.  Since the rising rates are happening in a profitable economy with strong growth forecasts and increasing dividend payouts (with an extra boost from the income tax reduction,) the variables impacting the equity duration are moving to love stocks rather than hate them.  This makes sense because interest rates may not drive equities but both can rise concurrently from the environment that lifts them.

The third reason to love equities in rising rate environments is that on average for every 100 basis point increase, every single sector, size and style gains.  Small-caps led, gaining 7.3% on average for every 100 basis point rate increase, followed by mid-caps that gained 5.9% and large-caps that gained 2.5%.  The growth acceleration that cancels the negative equity duration is the same growth that propels small-caps so much, putting them in a leading spot to rise with interest rates – especially since monetary policy is not too tight so that rising interest rates don’t hinder the borrowing by small companies too much. Also, look to the sectors reporting strong profits and paying high dividends to perform in this rising rate environment.  As reported in S&P DJI’s Market Attributes in Jan. 2018, 91.3% of Health Care, 83.7% Financial  and 88.2% Info Tech companies beat earnings estimates.  Also not surprisingly, Utilities, Telecom and Real Estate are the highest yielding sectors.  What is interesting is that small-cap financials have a 2.04% yield versus just 1.59% for large and 1.57% for mid cap, but over longer periods of accelerating interest rates, the large-caps do best in the financial sector.  This is since as rates rise, margins expand and with accelerating growth plus loose monetary policy, borrowers may be more active and banks can earn more from the spread. Source: S&P Dow Jones Indices and Federal Reserve Economic Data, Economic Research Division, Federal Reserve Bank of St. Louis. https://fred.stlouisfed.org. S&P 500 from Oct. 1971, S&P 500 Sectors from Oct. 1989, S&P 400 from Aug. 1991, S&P 500 Growth and Value from Feb. 1994, Real Estate Dec. 2001 and all others Jan. 1995.

Overall, this analysis on interest rates that shows support, mainly for small-caps, may help in understanding the macroeconomic impacts of GDP growth, inflation, and the dollar on U.S. equities.  There is overwhelming support for small caps followed closely by mid-caps, and for inflation protection, energy seems to be most sensitive.

 

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