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In This List

How Global Are the S&P 500®, the S&P MidCap 400®, and the S&P SmallCap 600® Style Indices?

Asian Fixed Income: Mega 30 in China Versus U.S.

Can “Being Green” Deliver Enhanced Returns?

Decomposing Recent Volatility Events Part 2

Assessing Single-Stock Risk in South African Indices

How Global Are the S&P 500®, the S&P MidCap 400®, and the S&P SmallCap 600® Style Indices?

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Phillip Brzenk

Managing Director, Global Head of Multi-Asset Indices

S&P Dow Jones Indices

In a prior post, we looked at the global exposure of the S&P 500. Given the large number of multi-national corporations based in the U.S., approximately 29% of S&P 500 revenues came from overseas in 2017. Beyond large-cap companies, do regional and country exposures change as investment style changes? In this blog, we add to the analysis performed on the S&P 500 and look at the differences in revenue exposure across the nine U.S. style boxes.

This analysis could potentially aid in understanding the differences between the indices beyond looking at size, fundamentals, or sector weights. We look at revenue exposure of the indices on a regional level, as well as on the country level. In addition, we review the total percentage of companies that are purely domestic in terms of revenue origination.

On a regional basis, the large caps have a higher level of geographic diversification compared to the smaller size segments. In addition, growth is more geographically diverse than value for large and mid caps, while the two styles have a similar level of revenue distribution in small caps. In particular, the revenue exposure to the Asia-Pacific region for growth is higher than the blend (overall benchmark) and value for both the S&P 500 and the S&P MidCap 400.

Small caps have the highest domestic exposure, at 79% of total sales, with mid caps sitting at 73%, and as mentioned previously, large caps at 71%. The trend of increasing U.S. exposure as one moves down the size scale is not surprising. Among other reasons, smaller companies are generally less mature and have less capital to grow their businesses internationally.

There is little differentiation in U.S. revenue exposure between growth and value for small- and mid-cap companies. However, in the large-cap space, growth (65% U.S. revenue) is more foreign-oriented than value (73% U.S. revenue) by a considerable amount. One driver of this is the relatively higher exposure that growth has to China at 5.6%, while value has an exposure of 3.8%.

Exhibit 3 lists the percentage of companies that only have domestic U.S. sales for each investment style. Nearly 23% of companies in the S&P 500 only obtain revenues from the U.S., but that figure jumps to 35% for the S&P MidCap 400, and 42% for the S&P SmallCap 600.

In terms of percent of holdings, nearly double the amount of small-cap companies are purely domestic compared to large-cap companies. When comparing large-cap growth to small-cap growth, the difference is more pronounced. In the S&P 500 Growth, just 15% of companies get all sales from the U.S., whereas the figure stands at 43% for the S&P SmallCap 600 Growth.  Overall, growth tends to include more geographically diversified companies, while value includes more purely domestic companies.

As we demonstrated, there are notable differences in the geographic sources of revenue among the domestic equity size and style indices. Further testing is required to establish whether cross-sectional differences in revenue origination explain return differences. However, at a minimum, market participants may need to keep in mind that certain market or economic events may affect a company or portfolio economically, and that impact could potentially be explained by where revenues come from geographically, and not just from its size (market-cap), fundamentals (growth/value), or line of business (sector/industry).

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

Asian Fixed Income: Mega 30 in China Versus U.S.

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Michele Leung

Former Director, Fixed Income Indices

S&P Dow Jones Indices

Despite the lackluster performance of Chinese bonds in 2017, the market value tracked by the S&P China Bond Index continued to expand and reached CNY 56.9 trillion (USD 9 trillion) as of Feb. 26, 2018. While it is the world’s third-largest bond market and remains far from the giant U.S. bond market (valued at USD 24.7 trillion, as represented by the S&P U.S. Aggregate Bond Index), global investors are increasingly interested in the opportunities in this growing market.

In light of this, let’s review the key characteristics of the two corporate bond markets. We first ranked and sorted the 30 largest bonds in the S&P China Corporate Bond Index and compared them against the S&P 500 Bond Mega 30 Indices.[1]

Key Highlights

  • 17 out of 30 Chinese corporate bonds had their issuers rated as investment grade by at least one rating agency (S&P Global Ratings, Moody’s, or Fitch), while the rest of the issuers were either unrated or rated high yield.
  • The Banks and Other Financial industries dominated and represented over 86% of the industry sector exposure in China (see Exhibit 1).
  • The U.S. has more diversified industry sector profiles in both investment-grade and high-yield indices; besides Banks and Other Financial, the Service Company industry, including pharmaceuticals and retail stores, has a sizeable representation, followed by Manufacturing and Energy Company (see Exhibit 2).
  • As of Feb. 26, 2018, the weighted yield-to-maturity of the 30 largest bonds from the S&P China Corporate Bond Index was 5.01%, comparable to the 5.08% of the S&P 500 Bond Mega 30 High Yield Index and higher than the 3.90% of the S&P 500 Bond Mega 30 Investment Grade Index.
  • The top five issuers of the three indices are listed in Exhibit 3.

Looking at performance since Sept. 30, 2015, the S&P 500 Bond Mega 30 High Yield Index outperformed and rose 28%, while the S&P 500 Bond Mega 30 Investment Grade Index gained 9.04% and the S&P China Corporate Bond Index gained 6.35%.

[1]   The S&P 500 Bond Mega 30 Indices are designed to measure 30 of the largest bonds from the S&P 500 Investment Grade Corporate Bond Index and the S&P 500 High Yield Corporate Bond Index. The index series is designed to be a more liquid and investable subset of the S&P 500 Bond Index, which seeks to track debt issued by companies in the S&P 500.

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

Can “Being Green” Deliver Enhanced Returns?

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Dr. Richard Mattison

Chief Executive Officer

Trucost, a part of S&P Global

We often hear of the need to address risks resulting from environmental issues in financial markets. Research by The Economist Intelligence Unit, “The Cost of Inaction,” estimates the value at risk from climate change impacts as ranging from USD 4.2 trillion to USD 43 trillion between now and the end of the century. Over time, as climate risks become more financially material, one would expect markets to positively reward companies that are taking steps to reduce their environmental impact.

At the end of 2016, I was delighted to announce the winners of an open research competition convened by the United Nations Environment Programme (UNEP) Finance Initiative Portfolio Decarbonization Coalition and the Sovereign Wealth Fund Research Initiative. The winners, a collaboration led by Soh Young In, Ashby Monk (Stanford University), and Ki Young Park (Yonsei University), received funding for a groundbreaking study into the correlation between financial performance and climate risk. Trucost donated its entire environmental performance dataset to the study.

Over the past 18 months, the research team assessed 74,486 observations of U.S. firms from January 2005 to December 2015. The study, “Is Being Green Rewarded by the Market?: An Empirical Investigation of Decarbonization Risk and Stock Returns,” discovered the following.

  • An investment strategy of “long carbon-efficient firms and short carbon-inefficient firms” would earn abnormal returns of 3.5%-5.4% per year.
  • Carbon-efficient firms are those with higher firm value measured in Tobin’s q, higher net income relative to invested capital (i.e., ROI), lower ROA, higher cash flow, and higher coverage ratio.
  • The statistical association of carbon efficiency with ROA, cash flow, and coverage ratio increases after 2009.
  • Findings are not driven by a small set of industries, variations in oil price, or changing preferences of bond investors caused by low interest rates regime starting with the financial crisis.
  • Extra returns cannot be fully explained by well-known risk factors, such as market size, value, momentum, operating profitability, and investment.

Improving Transparency in Financial Markets

Climate change is increasingly recognized as a global imperative and many assets are now exposed to physical, regulatory, and reputational risks. The EU High-Level Expert Group on Sustainable Finance, of which I am a member, has advised policy makers to integrate environmental, social, and governance (ESG) factors in the fiduciary duty of financial institutions. The Financial Stability Board’s Task Force on Climate-related Financial Disclosures has proposed enhanced reporting requirements for both companies and financial institutions. Good disclosure on climate risks will be increasingly important if market participants are to integrate such information into the investment process.

To improve transparency in financial markets, S&P Dow Jones Indices now publishes Trucost’s carbon metrics for equity indices on its website and Trucost has helped financial institutions with over USD 27 trillion in assets to identify environmental risks and opportunities across multiple asset classes.

Growing Evidence of the “Green Reward”

Some market participants have expressed concerns that low-carbon investment could lead to poor financial outcomes. The Stanford and Yonsei research study illustrates that this does not have to be the case, and in fact, low-carbon versions of the S&P 500® were found to outperform their benchmarks over one-, three-, and five-year periods, providing further evidence of the “Green Reward.”

Enhanced Climate Data and Risk Analysis Will Be Essential

Trucost and S&P Dow Jones Indices provide data, tools, and benchmarks to comprehensively analyze climate risk and many other environmental factors. This latest study on the correlation between financial performance and climate impact illustrates that climate risk analysis can deliver enhanced returns and reduced risk over time. Many market participants are increasingly demanding better-quality data and analysis in order to mitigate portfolio-wide climate risks and deliver enhanced returns.

If you enjoyed this content, join us for our Seminar Discover the ESG Advantage in
London on May 17, 2018.

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

Decomposing Recent Volatility Events Part 2

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Berlinda Liu

Former Director, Multi-Asset Indices

S&P Dow Jones Indices

In my previous blog, we compared a daily inverse index to a “true short” and discussed the increasing vega exposure in the S&P 500® VIX® Short Term Futures Inverse Daily Index over the past couple of years. In this blog, we analyze how the mechanics of a VIX futures index, a low volatility environment, and various forces in the market may have contributed to the after-hour spike of VIX futures contracts on Feb. 5, 2018.

Rolling of VIX Futures Is a Double Edged Sword in VIX Futures Index Performance

The benchmark VIX futures index, the S&P 500 VIX Short-Term Futures Index, replicates a rolling futures position on the CBOE Volatility Index (VIX) using the two nearest futures contracts on VIX. That means that its inverse, the S&P 500 VIX Short Term Futures Inverse Daily Index, theoretically is buying the front-month futures and selling the second month’s futures on a daily basis. In a contango market, which occurs about 80% of the time in the history of the index (shown in Exhibit 3 in this post), this buying/selling can translate into positive carries in the long term. However, a huge jump in volatility and an inversion of the VIX futures curve could result in a double blow on the S&P 500 VIX Short Term Futures Inverse Daily Index and the exchange-traded products (ETPs) that track it.

VIX ETPs, Other Institutional Investors, and the After-Hour Spike in VIX Futures

VIX ETPs rebalance after market close once they get the target weights for the next business day. Even though the size of the VIX ETP market is small relative to the overall U.S. equity market, it is sizable relative to the VIX futures market. A recent research piece published by Goldman Sachs, “VIX: Q&A on the Trading Dynamics of ETPs,” estimated that the size of the VIX ETP market accounts for roughly 40% of open interest of the VIX futures market.

When volatility rises, market participants are economically incentivized to buy VIX futures: the inverse VIX ETP issuers may do so to reduce a short position that has become too large; the leveraged VIX ETP issuers may do so to supplement a long position that has not risen as quickly as the AUM of the ETP itself. Goldman Sachs research group estimated that the after-hour “vega to buy” on Feb. 5, 2018, exceeded 200,000 VIX futures.

It is worthwhile to note that institutional investors that have also employed short volatility strategies would likely need to buy VIX futures to cover their short positions. The same applies to the systematic strategies that may have had hedging triggered. The end result of these combined forces is an accelerated price spike in VIX futures contracts in extended trading hours (see Exhibit 1).

Low VIX Levels Increased the Probability of a 100% Jump

Finally, VIX had been hovering in the lower teens for quite a long time. The lower level of VIX futures also made an n-point move a higher percentage than it would be with higher VIX futures prices. For example, a 10-point jump would be a 100% return with the VIX level at 10, and a 50% return with the VIX level at 20.

In conclusion, several variables appear to have contributed to the recent events witnessed in the VIX space. The combination of capital flowing into inverse ETPs, the compounding power of daily inverse indices and their index-linked ETPs, systematic trading strategies, a low VIX environment, a jump in volatility, and an inversion of the VIX futures curve together led to an accelerated rally in VIX as demonstrated by the ultimate drawdown in the inverse version of the asset class. The key takeaway for market participants from this event is that volatility is a complex asset class and one that has various players interacting at different levels based on their own economic interests. Therefore, understanding the mechanics of VIX futures and VIX futures indices should be a starting point for any volatility market participant.

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

Assessing Single-Stock Risk in South African Indices

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Michael Orzano

Head of Global Exchanges Product Management

S&P Dow Jones Indices

Investing in stocks can be risky. However, investing in a single stock tends to be far riskier than investing in a diversified basket of stocks. South African investors received a jarring reminder of this in early December, when Steinhoff International Holdings dropped more than 80% in the two days following the international retailer’s disclosure of accounting irregularities.

Mitigating the impact of these idiosyncratic risk events through the use of broad-based indices is one of the reasons that many market participants have turned to index-based investing over the years. However, all indices are not created equal when it comes to the extent of risk posed by single companies. Even among seemingly similar indices, it’s important to look under the hood to understand precisely how the index measures the market segment it seeks to represent.

South Africa’s large-cap equity indices provide an interesting case study in this. Over the past several years, the tremendous growth of Naspers has resulted in the company representing nearly a quarter of the market-cap-weighted FTSE/JSE Top 40. However, because the S&P South Africa 50 incorporates a single-stock cap of 10%, the influence of Naspers (or any other company for that matter) is reduced (see Exhibit 1).

The potentially devastating impact of a large portfolio holding sharply dropping in price is obvious in a general sense. However, Exhibit 2 provides a simple illustration of the quantitative impact for a range of hypothetical scenarios. For example, if a company represents 50% of an index and its price drops 75%, the impact on the index—holding all else equal—would be a loss of 37.5%.

While Steinhoff is a component of the S&P South Africa 50, the overall impact was mitigated by the company’s relatively small weight. Prior to the accounting disclosure, the company represented less than 2% of the S&P South Africa 50, so its 80% decline translated to a loss of roughly 1.4% for the index.

However, what if Steinhoff was much larger and had a 25% weight in the index? An 80% decline in a stock that represents 25% of an index would have resulted in a much larger 20% overall index loss. In light of recent events, perhaps now might be a good time to check how much exposure there is to any one company in your index.

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