Indexology^® Blog

In accordance with the announced upcoming communication services sector change, the new Communication Services Select Sector Index is now live.  The select sectors are based on the Global Industry Classification Standard (GICS®) but have different construction rules than the sectors of the S&P 500.  In the Select Sectors, each index is made up of all stocks in the GICS sector unless otherwise noted in the table below.Source: S&P Dow Jones Indices. S&P U.S. Indices Methodology. 1 The Communication Services Select Sector Index reflects the changes in the GICS structure effective in September 2018. For more information regarding the composition of the Communication Services Sector, please refer to Appendix D. S&P Dow Jones Indices has created back calculated history for the Communication Services Select Sector Index based on the securities in the headline S&P 500 that would have hypothetically been classified as GICS Code 50 at that time under this new structure. 2 In order to align with the GICS structure changes effective in September 2018, S&P DJI will remove stocks classified as Communication Services (GICS Code 50) from the Technology Select Sector Index.

Furthermore, the weighting of the constituents inside the select sectors follows the capped market capitalization weighting. In short, there is a quarterly rebalancing where each company is float adjusted market cap weighted with capping to limit companies to under 25% each, and to limit the sum of companies with weights greater than 4.8% to under 50% of the index (The full details of the weighting can be found in the methodology on pages 12-13).

The new sector map is discussed in detail in this post, but as a reminder is shown below:

Now that the Communication Services Select Sector Index is launched, here is what it looks like on the inside with return results based on ten years of backtested history.  The index has 26 constituents with a total market cap of $2.35 trillion, average market cap of $92.5 billion and median market cap of $34.9 billion as of May 16, 2018.

The constituents are from the current GICS classification sectors of information technology (blue,) consumer discretionary (yellow) and telecommunications (green.)  There are 6 constituents from Information Technology with a total market cap of $1.24 trillion, 17 constituents from Consumer Discretionary with a total market cap of $856.6 billion and 3 constituents from Telecommunication Services with a total market cap of $254.2 billion.

Lastly, the index level history and performance below uses data from Dec. 21, 2007 based from 100 that is backtested before the launch on April 30, 2018.  The Communication Services Select Sector Index returned a cumulative 143.5% through May 16, 2018 with annualized performance of 14.2% over 3 years, 12.7% over 5 years and 9.9% over 10 years.  The index also has a one year return of 11.6% and is up 3.8% year-to-date.

Source: S&P Dow Jones Indices. Launch date is April 30, 2018.  All prior data is backtested. 

Having broken through 2% in January 2018, the 10-year U.S. Treasury breakeven rate (as measured by the difference between the S&P U.S. Treasury Bond Current 10-Year Index and the S&P U.S. TIPS 10 Year Index) has continued to increase, reaching a YTD high of 2.18% on April 23, 2018.

As of May 14, 2018, the breakeven level sat at 2.16%. These levels have not been seen since late August 2014. A rise in oil prices to around USD 70 per barrel has boosted inflation expectations, but not to the point of being “runaway” levels. A weak U.S. dollar has pushed oil prices up more in the U.S. than in other countries.

U.S. consumer prices rose less than expected for April 2018 (0.1% versus the prior 0.2%, Core CPI month-over-month), leading to speculation that the Fed will be gradual in its future rate increases. Two additional rate hikes have been the market’s expectation for 2018.

Though the U.S. Jobless Claims number was unchanged at 211,000, continued tightening in the labor markets, wage growth, and GDP (2.9%) growth will likely have an impact on inflation.

Housing prices continue to climb as the S&P CoreLogic Case-Shiller 20-City Composite Home Price NSA Index reported an increase of 0.7% for the end of February 2018. Seattle, Las Vegas, and San Francisco continue to report the highest year-over-year gains among the 20 cities. All of the cities reported increases before and after seasonal adjustment, and the index has eclipsed its July 2006 peak by 0.1%.

For now, the inflation picture seems to be a slow rise, with the breakeven rate hovering around the current level of 2.16%.

Exhibit 1: Breakeven Inflation Rate

Following similar studies performed by S&P Dow Jones Indices on active funds in the U.S. and Australia, we introduce the Persistence Scorecard to the Latin America region. The two aforementioned studies have demonstrated that top-performing active funds have little chance of repeating that success in subsequent years. To determine if similar conclusions can be made in Latin America, we examined active funds in Brazil, Chile, and Mexico.

The Persistence Scorecard: Latin America Year-End 2017 presented two key statistics. First, the performance persistence of top-performing active funds that remained in the top-quartile or top-half rankings over consecutive three- and five-year periods was measured. Second, transition matrices showed the movements of funds between quartiles and halves over two non-overlapping, three-year periods. The transition matrices also tracked the percentage of funds that later were merged or liquidated during the study period.

Exhibit 1 measures the performance persistence of the top quartile of funds based on performance in 2013 (Year 0). The performance of these funds was compared with the respective universe for each of the next four years to determine if they were able to sustain top performance.

Across all categories, few funds were able to maintain top-quartile status over the five-year horizon. After just one year, the most successful category was Brazil Equity, in which 56% of funds stayed in the top quartile. While this was the most successful category, it also meant that nearly half of the funds that were top performers in 2013 were unable to maintain their performance after just one year. By year three, several categories had zero remaining funds in the top quartile, and by year four, five of the seven categories had zero remaining funds. These results showed that regardless of fund category, active managers were unable to persistently produce top results.

In Exhibit 2, we separated each country’s equity category into quartiles based on an initial three-year performance period (2012-2014). The performance of the subsequent three-year period (2015-2017) was then measured for each fund to obtain two non-overlapping periods of performance. Looking at these two periods, we used a transition matrix to show the movements between quartiles from the first period to the second period.

In Brazil, 60% of the funds that were in the first quartile for the first period ended up in the first or second quartile in the second period. For the second through fourth quartiles in the first period, more funds ended up merging with another fund or liquidating than sitting in one of the four quartiles (darker shades of blue signify higher frequency). In Chile, more funds shut down than resided in any of the four quartiles by the end of the second period. For the first quartile in the first period, funds that survived remained top performers in the second period, but the overall majority of funds (60%) ended up no longer being in existence. No clear trend was observed in Mexico. More funds in the top quartile in the first period transitioned to the bottom quartiles in the second period than remained in the first quartile or moved to the middle quartiles. Funds in the second and third quartiles generally moved up to the first quartile in the second period, while most funds in the fourth quartile continued to show poor performance. In essence, the results in Mexico were a coin flip.

The initial scorecard for Latin America echoed results found in the other regions—the vast majority of top performing funds were not able to deliver top performance in future years.

To see the full results, the scorecard can be found here.

I spent a recent weekend at the Self-Managed Superannuation Fund (SMSF) Expo talking to SMSF trustees about indices. While I often spend Monday through Friday talking indices, to spend Saturday and Sunday chatting about indices was something new. The SMSF Association hosted the first SMSF Expo in Australia, attracting over 1,500 people over the three-day Expo. SMSFs represent about one-third (or AUD 721 billion) of Australia’s total superannuation asset pool of AUD 2.3 trillion, as of Dec. 31 2017.[1] These funds enjoy much greater flexibility in terms of investment choices, including the ability to borrow and leverage. There are over 1.24 million SMSF trustees in Australia.

The most common question asked of me at the Expo was, “What does S&P Dow Jones Indices offer to SMSF Trustees?” My answer was that we primarily give away education, and from that point, I launched into sharing the findings from our SPIVA^® Australia Year-End 2017 Scorecard, as well as the findings from the Persistence of Australian Active Funds: March 2018. With SPIVA, I always find it helpful to start with the infographic that shows the SPIVA phenomenon is not just something that occurs in Australia, but that in many markets, active managers find it hard to outperform their respective benchmarks.

After sharing the SPIVA and persistence findings, it was an easy segue to handing a trustee the ticker sheet of all ETFs in Australia and New Zealand that track an S&P DJI index. Armed with the research and ticker sheets, trustees who had not as yet invested in ETFs were then in a position to consider how these vehicles could form part of their portfolios.

But it wasn’t only SMSF trustees who attended the Expo. There were also financial advisers, many of whom are converts to the ETF cause, but had never met anyone from an index provider and were thrilled to know that there are myriad resources available to share with clients. It’s always satisfying to talk to advisers and trustees who advocate passive investing, but the real thrill at events of this nature is when you are explaining passive investing and indexing, sharing SPIVA or persistence results, and you see the dawn of realization on the faces of the people you are speaking with as they get why passive investing is growing and how easy it is for them to access passive investment vehicles.

[1]   Source: APRA, Quarterly Superannuation Performance December 2017

On July 9, 2007, S&P Dow Jones Indices launched the S&P GSCI Biofuel, which aims to provide market participants with a reliable and publicly available benchmark for investment performance in the feedstock commodities used in the production of biofuels. The index includes Chicago wheat, corn, soybean oil, and sugar.

Biofuels are produced utilizing biological processes, are renewable, and are intended to replace fossil fuels such as gasoline for transportation, which is not renewable. Biofuel was first used as fuel in a diesel engine in 1898. In 1918, blended gasoline was first invented and was used extensively during World Wars I and II due to oil shortages. The Clean Air Act was signed by Nixon in 1970, and in 1992, the Common Agricultural Policy allowed land to be designated for the planting of crops for biofuel production. In 2001, E15 (or 15% ethanol/85% oil fuel) was officially allowed in the U.S., and in 2007, President Bush signed the Energy Independence and Security Act, which mandated the increase of ethanol usage in the U.S. Exhibit 2 depicts the subsequent U.S. regulatory implementations as they related to the performance of the S&P GSCI Biofuel.

As seen in Exhibit 2, the S&P GSCI Biofuel tended to perform better during and subsequent to the implementation of new regulatory environments that supported the production and utilization of biofuel.

Exhibit 3 drills into the performance of the index during the month of May 2018, when U.S. President Donald Trump announced that he was considering allowing exported ethanol to count toward the volumes mandated under the nation’s biofuels law, a move that could benefit both the oil and corn industries in the U.S.[i]

The S&P GSCI Biofuel increased 0.9% on the day of the announcement (May 8, 2018), while the S&P GSCI Unleaded Gasoline declined by 1.1%.

Exhibit 4 depicts the annual correlation between the S&P GSCI Biofuel and the S&P GSCI Unleaded Gasoline. While the indices had a correlation of 0.2 for the entire period evaluated, the annual correlation levels fluctuated.

It can be seen that the correlation between the two indices was low or reflective of the entire period correlation during the “regulatory years” (2007, 2010, 2011, and 2018). The highest correlation levels were during 2008, when all commodity prices experienced a sharp downturn as a result of the credit crunch and sovereign debt crisis, and in 2016, when petroleum prices benefited from robust demand and biofuels strengthened as a result of increasing the Renewable Fuel Standard targets.[i]

[i]   Source: https://www.eia.gov/todayinenergy/detail.php?id=29132

[i]   Source: https://www.reuters.com/article/us-usa-trump-biofuels/trump-to-soon-propose-sweeping-changes-to-biofuel-laws-source-idUSKBN1IC263