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The Evolution of Indian Indices

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

The Evolution of Indian Indices

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Alka Banerjee

Managing Director, Product Management

S&P Dow Jones Indices

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A recent stipulation by SEBI for the mutual fund industry outlines how to treat size classifications and suggests that funds need to be very explicit in their stock selection and fund categorization when it comes to stock sizes. SEBI laid down rules for categorizing funds based on component stock sizes and fund houses have to adopt the rules by the first quarter of 2018. Index providers in India have been providing size indices for many years but index selection by asset managers has tended to disregard these criteria in favor of more customized approaches. As investor attention in India has focused more on indices, the natural value that indices bring to investors has grown in importance. Indices provide transparency, rules and a clean structure to the investment landscape and the result can be beneficial for investors.

In India, the quality and design of indices has evolved considerably over time. With the partnership of S&P DJI with the BSE, for the first time the benefits of global indexing standards were brought to the local market. In the last four years alone, Asia index Pvt. Ltd (Asia Index) has launched more than 75 new indices ranging from size, sector, thematic and smart beta. Indices are designed to provide a range of investment choices and Asia index has striven to do just that. On the one hand we have the S&P BSE 30, a liquid investable gauge of the Indian stock market and on the other we also have the S&P BSE AllCap index which is a broad comprehensive index series covering more than 90% of the total market capitalization of the market and is modular with an ability to slice as per size, sector and industry. Similarly smart beta indices for low volatility, value and momentum and other factors are all offerings available to the India investor. Most recently, an ESG (environmental, social and corporate governance) index which selects stocks based on their ESG scores has been launched. Fixed income indices have been available from CRISIL for some time too and have been quite popular with investors.

While the use of indices is just beginning to take off in India, the rapid growth in the number of new index launches from various providers has grown exponentially, with the expectation that markets are maturing rapidly and demand for well-designed and indices will ratchet up. The world of indexing is constantly growing and evolving and the Indian index providers have geared up to match the global pace.

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

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

Senior Director, Strategy Indices

S&P Dow Jones Indices

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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

Director, Fixed Income Indices

S&P Dow Jones Indices

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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

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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

Director, Global Research & Design

S&P Dow Jones Indices

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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.