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Mexican Currency and Elections

Can small-cap outperformance continue?

Responsible Investor Europe 2018 Conference: ESG Grows Up

Indexing Route to Large Caps

Understanding the Asset Class Risk Contribution of the S&P/BMV Mexico Target Risk Indices

Mexican Currency and Elections

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Jaime Merino

Former Director, Asset Owners Channel

S&P Dow Jones Indices

General elections (president, senate, and chamber of deputies) are around the corner. The eyes of every Mexican and many people around the globe are on the Mexico-Brazil match of the World Cup—wait, that is another story.

Nobody knows what the outcome of the elections will be. We have seen different events where the polls were wrong (for instance, Mexico beating Germany in the match on June 17, 2018). However, the market incorporates these expectations in many ways, one being the currency. Exhibit 1 shows how the Mexican peso performed before and after the past two elections (2006 and 2012) compared with the U.S. dollar.

We can see that before the elections, the tendency in 2012 and 2018 was similar, and after the elections in 2006 and 2012, the tendency was an appreciation of the currency. We know that the elections are not the only factor moving the Mexican peso—for example, in 2018 due to the NAFTA, it has shown a lot of volatility.

Exhibit 2 shows how the S&P/BMV Sovereign International UMS Bond Indices, which are designed to measure the performance of Mexican government securities issued outside of Mexico in U.S. dollars, performed before and after the elections.

In 2018, the elections have not been the only factor affecting the Mexican peso. The Mexican Central Bank has followed the U.S. Fed’s policy decisions and moved up the overnight interbank interest rate 50 bps to stand at 7.75%. In 2012, the rate was steady at 4.50%.

Any outcome on Sunday, June 30, 2018, will surely have an impact on Mexico. By nightfall, we may have a newly elected president, but at 9:00 am (local time) on Monday, July 2, 2018, Mexico will play against Brazil in the World Cup. Looks like attention to the news to see how the elections went will have to be shared with the match!

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

Can small-cap outperformance continue?

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Nick Kalivas

Senior Equity Product Strategist


Small caps have materially outperformed large caps in 2018, with the S&P SmallCap 600 outpacing the S&P 500 7.80% to 2.58% between Dec. 29, 2017, and May 25, 2018.1 Below, I highlight what I believe to be the drivers of small-cap returns this year, and why I believe the trend could continue.

Tax cuts have benefited small caps. In the three years ending December 2017, the companies in the S&P SmallCap 600 had an average effective tax rate 4.3% higher than the S&P 500.1 Investors looking for stocks that may experience improved profitability due to US tax reform seem to have turned to the small-cap sector.

Trade tensions may favor small caps. 2018 has been a year of trade tensions, but smaller companies tend to have less overseas exposure than larger companies. S&P SmallCap 600 companies generated 78.8% of their revenues from the US compared to 70.9% for the S&P 500.2 The difference was even more dramatic in the growth style box, where S&P SmallCap 600 Growth companies produced 80.6% of their revenue from the US compared to 65.1% for S&P 500 Growth companies.2 The recent political tensions in Italy and Spain and the potential threats to economic growth in the eurozone may prompt investors to reduce their overseas exposure and benefit small caps relative to large caps.

The trend in earnings estimate revisions favors small stocks over large. Earnings estimate revisions have been strongest in the small-cap sector. Forward earnings estimates for the S&P SmallCap 600 have risen by more than 28% compared to 18.7% for the S&P 500 over the past six months.3

The US economy has shown relative strength. More recently, the US economy has continued to display strong growth, while economies in Europe and Asia have softened. The IHS Markit Eurozone Manufacturing PMI has declined from a peak of 60.6 in December 2017 to a recent low of 55.5 in May 2018, while the Nikkei Japan Manufacturing PMI has eased from a January 2018 high of 54.8 to a recent low of 52.8 in May.4 In contrast, the IHS Markit US Manufacturing PMI was just below its cycle high at 56.4 in May.4

Investors may be choosing small caps over emerging markets for their risk sleeve. Investors may  have become uneasy over emerging markets due to geopolitical tensions (the Turkish lira crisis, instability in Venezuela, and Russian sanctions, for example), a rising 10-year Treasury yield, and a firmer dollar that has rallied from its February low. The risk sleeves of portfolios may have tilted toward small caps.

Small-cap valuation has become more attractive. Some see better value in small caps as the price-to-earnings (P/E) ratio has compressed on the S&P SmallCap 600, suggesting that small caps have cheapened in recent years. On a forward earnings basis, the S&P SmallCap 600 is currently trading at 20.1 compared to 17.0 for the S&P 500. The ratio of 1.18 is down from a peak of over 1.33 in July 2009.5

The technical picture is supportive. Using technical analysis can be a risky proposition, but the technical set up of the S&P SmallCap 600 looks bullish, in my view. The index has broken out of consolidation to the upside in a near textbook ascending triangle. The target of the triangle projects over 1075 based on the depth of the formation (this measure is approximate – this is an art not an exact science). Another target would be the top of a channel formed off the lows of the triangle. This is a moving target, but higher than current levels and consistent with the 1075 level.  However, the small-cap sector appears to be overbought in the near term given the Relative Strength Index was recently over 73, but pullbacks to the hold highs in the 980 area may have the potential to provide support. Old resistance levels tend to become supportive (the top of the triangle).

1 Source: Bloomberg L.P.

2 Source: S&P Dow Jones Indices, “ How Global are the S&P 500, the S&P Midcap 400, and the S&P Smallcap 600 Style Indices?” Feb 28, 2018.

3 Source: Bloomberg, L.P. as of May 242018

4 Source: IHS Markit

5 Source: Bloomberg, L.P. as of May 312018

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

Responsible Investor Europe 2018 Conference: ESG Grows Up

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Kelly Tang

Former Director

Global Research & Design

The 11th annual Responsible Investor (RI) Europe Conference, held June 5-6, 2018, showed a marked departure in ESG themes and focus from previous years. Compared with prior sessions, there was a strong shift and a coming of age in the ESG movement. For example, the title for the keynote plenary of the RI 2018 Conference was aptly called “Action Speaks Louder Than Words.”

The mindset permeating through sustainable finance policy makers, practitioners, and investors is that of action and implementation. One example that highlights this call for implementation is the lack of breakout sessions regarding ESG data, which, in previous years, has been a prevalent and frequently discussed topic. In multiple previous RI conferences, topics centered on data consistency, data coverage, and data developments were commonly found on the agenda. In fact, one panelist from an asset owner exclaimed, “Let’s stop asking for perfect or more data. The data is good enough, and we need more action. It’s the next logical step.”

What is now evident to many attendees is that the drivers for this shift in mindset and heightened sense of urgency for sustainable investing derive from the following.

  1. The backdrop of a political shift signaling a retreat to nationalistic priorities, shunning global issues such as ESG. There is a sense that ESG participants need to make sustainability a real part of public discourse sooner rather than later and show how it can be a driver of sustainable economic success. Part of that sentiment stemmed from the U.S. withdrawal from the Paris Accords, along with the subsequent U.S. Department of Labor memo. It became evident that time is not a luxury and that ESG participants need to get to work and show the tangible benefits of ESG.
  2. Task Force on Climate-related Financial Disclosures (TCFD) recommendations have been out for one year, and since the launch of the final report, hundreds of organizations have been working on disclosing climate-related financial information, and a myriad of resources are being developed to support them in the process. In May 2018, the TCFD and the Climate Disclosure Standards Board (CDSB) launched the TCFD Knowledge Hub, the first online platform dedicated to the latest resources, tools, and insights on their recommendations. Policy makers and initiative organizations have done their part and now practitioners need to start implementing.
  3. The European Commission has confirmed its first four legislative proposals to spur sustainable finance in the region, covering green definitions/taxonomy, investor duties, retail investing, and benchmarks. At the 2018 conference, there were more policy makers than ever speaking as to what regulators can do to move quickly on implementing financial measures to tackle climate change. The desire is to complete as much as possible within the current political cycle in order to avoid political regime shifts that are not favorable to ESG.

In reference to the benchmark proposal of the European Commission’s legislative proposals, the topic has quietly risen up the agenda, and the European Commission has confirmed that it will use a delegated act to create a new category of benchmark. There will be two benchmarks, the first will be a conventional low-carbon benchmark aiming to decarbonize standard benchmarks by selecting stocks with lower emissions. The second benchmark will be more ambitious and will seek to meet the Paris Agreement whereby a company’s carbon savings outstrip its carbon emissions.

Another dominating theme was the recent guidance on ESG by the U.S. Department of Labor’s field assistance bulletin. Multiple panelists (including Anne Simpson, Investment Director of Sustainability at CalPERS) agreed that the memo should not be viewed as a doom and gloom scenario for ESG, but as an opportunity to incorporate more discipline, analysis, and documentation into ESG investing that will ultimately help propel it into the mainstream.

In our previous blog, we also highlighted that the Department of Labor’s bulletin serves as an opportunity for analysis-driven ESG investing that strikes the right balance between integrating ESG issues and empirical results.

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

Indexing Route to Large Caps

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Koel Ghosh

Former Head of South Asia

S&P Dow Jones Indices

“Trying to pick individual stocks is a trap. I can’t do it. Warren Buffett can, but hardly anyone else can beat the indexes over a long period of time.”

Ben Stein

The above quote is proof that Ben Stein seems to understand the merits and traits of indices and index-linked products. There is a varied range of investment strategies that are at play today that can help achieve targeted objectives. Coupled with constantly shifting market dynamics, these strategies are continuously changing as well, though some of the basics are the same—whether the strategy is active or passive, dynamic or tactical, core or satellite. Asset allocation strategies are always interesting, as they vary based on investment objectives, market dynamics, investor profile, and so on. At times, there are stock-specific strategies, or sometimes strategies are based on sectors, themes, or even factors. However, index-based strategies or investments offer the advantages of a diversified basket of stocks that is designed by an independent index provider based on a transparent, rules-based methodology. The advantage of indexing is now being further highlighted with statistics that support how active funds are being outperformed by their benchmark indices. The SPIVA® India Scorecard, which has been publishing data since 2013, displays this growing trend.

One of the areas where this trend is escalating in India is the large-cap segment. Exhibit 1 displays significant outperformance in the five-year category over the past four years. In the last two years, more than 50% of active funds underperformed the benchmark S&P BSE 100.

Exhibit 1: SPIVA India Reports – Percentage of Indian Equity Large-Cap Funds Outperformed by the S&P BSE 100
Year-End 2013 78.53 66.67 69.23
Mid-Year 2014 34.18 60.36 54.36
Year-End 2014 23.81 57.94 52.94
Mid-Year 2015 28.30 49.59 60.50
Year-End 2015 35.79 46.79 56.52
Mid-Year 2016 53.26 39.42 58.62
Year-End 2016 66.29 30.52 54.60 54.95
Mid-Year 2017 52.87 34.19 50.93 58.47
Year-End 2017 59.30 53.00 43.40 53.54

Source: S&P Dow Jones Indices LLC. Data as of year-end 2017. Past performance is no guarantee of future results. Table is provided for illustrative purposes.

This offers an opportunity to evaluate the large-cap segment using a passive strategy. The S&P BSE suite of indices offers options in this segment via the S&P BSE SENSEX, S&P BSE SENSEX 50, S&P BSE SENSEX Next 50, S&P BSE 100, and S&P BSE LargeCap. These indices provide options from choosing a core set of 30 constituents, as in the S&P BSE SENSEX, to increasing that exposure to 50 stocks in the S&P BSE SENSEX 50, to further extending to 100 with the S&P BSE 100 if the goal is more diversification. Even though they all belong to the same large-cap segment, each index displays different returns and trends based on its characteristics. Hence, for shifting asset allocation strategies, there is a complete range to choose from.

Exhibit 2: S&P BSE Indices in the Large-Cap Segment


S&P BSE SENSEX 15.08 9.84 13.89 9.54
S&P BSE SENSEX 50 14.48 10.52 14.44 9.93
S&P BSE SENSEX Next 50 4.44 10.52 16.83 10.44
S&P BSE 100 12.82 10.47 14.61 9.71
S&P BSE LargeCap 13.19 9.98 14.22 9.61

Source: Asia Index Private Limited. Data as of May 31, 2018. Index performance based on total returns. Past performance is no guarantee of future results. Table is provided for illustrative purposes and reflects hypothetical historical performance. The S&P BSE SENSEX 50 was launched on Dec. 6, 2016. The S&P BSE SENSEX Next 50 was launched on Feb. 27, 2017. The S&P BSE LargeCap was launched on April 15, 2015.

The recent guidelines from the Securities Exchange Board of India have formalized the large-cap space as the top 100 stocks by market capitalization. Hence, it’s worth considering the indexing route to large-cap exposure as a low-cost, transparent, and flexible mode to achieve allocation to the large-cap segment.

Learn more about SPIVA on a global scale on INDEXOLOGY®.

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

Understanding the Asset Class Risk Contribution of the S&P/BMV Mexico Target Risk Indices

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Maria Sanchez

Director, Sustainability Index Product Management, U.S. Equity Indices

S&P Dow Jones Indices

The S&P/BMV Mexico Target Risk Index Series comprises four multi-asset class indices that are designed to serve as benchmarks for the Mexican pension system based on the risk tolerance levels of plan participants. Generally, younger individuals with longer time horizons until retirement will have greater risk tolerance and therefore higher exposure to risky assets such as equities, while older individuals will allocate to more conservative assets such as short-term nominal and inflation-linked bonds. As outlined in our paper, “Benchmarking Lifecycle Investment Strategies: Introducing the S&P/BMV Mexico Target Risk Indices,” we used liquid, investable indices to represent each asset class.

Designed to represent investment strategies with varying levels of risk appetite, the indices allocate across various asset classes to meet their respective risk target. Therefore, it is important to understand the sources of portfolio risk. In this blog, we decompose the risk of each portfolio by asset class so that we can identify and attribute the portion of realized risk coming from each index.

In order to assess the contribution of each asset class to portfolio risk,[1] we first calculate the weighted covariance matrix of all the indices representing each asset class in the index series. As seen in the equations in the footnote, the contribution of a given asset class to portfolio volatility is computed by the correlation between that asset class and the index portfolio multiplied by the volatility of the asset class in question and its weight in the index portfolio. Correlation and volatility are estimated using daily returns over one-year periods from 2009 through 2017.

We then get the percentage of contribution to total portfolio risk by dividing the asset class (or the index) contribution by the total portfolio volatility. The sum of all the contributions must be equal to the total portfolio risk and the sum of the asset class percentages of contributions to portfolio risk must be equal to 1 (or 100%).

Exhibit 1 charts the realized portfolio risk of each S&P/BMV Mexico Target Risk Index, the risk contribution to the index for each asset class, and the percentage of contribution to the total risk for each asset class on an annual basis. For example, in 2017, the total risk of the S&P/BMV Aggressive Target Risk Index was 3.65%, of which 1.36% was from the equity portion, contributing to 38% of the overall risk. The contribution to portfolio risk by the equity portion rose after declining to 34% in 2016.

As we noted in our paper, there are periods, such as 2013, when the aggressive portfolio underperformed its growth, moderate, and conservative counterparts due to asset allocation mix. A close examination of asset class contribution to risk provides some insight. For example, in 2013, the biggest contributor to the total risk of the S&P/BMV Mexico Target Risk Aggressive Index came from fixed income, namely the S&P/BMV Sovereign MBONOS 20+ Year Bond Index. At roughly 28% of portfolio total risk, its risk contribution was higher than that of the equity portion (see Exhibit 2).

In this blog, we highlighted the importance of understanding the sources of portfolio risk. Asset allocation strategies, such as the S&P/BMV Mexico Target Risk Indices, require decomposition of portfolio risk so that market participants are aware of where the risk is coming from and can assess the impact of each asset class on the overall portfolio.

[1] To calculate each asset class contribution to risk, we start by defining the portfolio volatility as 

From this equation, the risk contribution of each asset class can be derived as

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