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Setting Income Goals For A Winning Retirement

S&P Dow Jones Indices Quarterly Islamic Market Review

The Importance of Sector Diversification in a Yield-Focused Strategy – Part I

ESG Strategies on the Rise

One Big Problem In July For One Small Cap Index

Setting Income Goals For A Winning Retirement

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Jodie Gunzberg

Former Managing Director, Head of U.S. Equities

S&P Dow Jones Indices

“You Keep Livin’, We’ll Keep Payin'” – lottery spokeswoman, Christy Calicchia.  Most people, while they only dream of winning a lottery, understand the concept between a big lump sum payout and an annuity that says something like “either win $1 million today or win $1,000 a week for life.”  Though the concept is clear, and in many cases the annuity is worth more, lottery winners almost always choose the lump sum.

Although paying for retirement is not quite like winning the lottery, of course since working and saving are part of the retirement equation, there is a similar concept.  It is difficult for retirement savers to reframe their thinking from “How much do I need at retirement?” to “How much monthly income do I need to replace in order to comfortably live through retirement?”

To answer the question of how much it costs to retire, Marlena Lee, co-head of research at Dimensional Fund Advisors, joined S&P Dow Jones Indices to discuss the pillars of retirement income choices and how to manage the risks to secure better outcomes.

According to Ms. Lee, the key element in plan design to improve retirement outcomes is to set up the right goal for retirement to provide income through retirement.  For example, a goal should be achieving a level of annual income that supports a desired standard of living in retirement.  Once that goal is defined, then there are two additional things to do in order to line up both the communication as well as the investment.  It’s really important to communicate to participants in income terms since it might be different to say, “you need to save a million dollars by the time you retire” as opposed to, “you need to replace five thousand dollars of monthly income throughout your retirement.”

Secondly, but just as important, the investments need to be designed to reduce the risks that can impact retirement income such as market risk, inflation and interest rates.  These matter to provide income in real terms and understand how much people can withdraw from their portfolios in retirement.

An effective solution should enable plan sponsors to provide meaningful estimates to participants on how they are doing relative to their income goal, empowering them to make better decisions toward achieving desired retirement outcomes.  To help plan sponsors evaluate success, S&P STRIDE (Shift To Retirement Income & Decumulation) indices work in two major ways.  The first is by the allocations and the second is by the constituent selection.  The family of indices publishes weights according to glidepaths in the methodology and uses indices for corresponding asset class betas to fill in the positions.  The attribution can be done to measure the impact from weights or security (fund) selection.  

Despite the external forces on retirement income, there are three main variables a plan participant can control: how much to save, when to retire, and how much income will be needed in retirement. More income in retirement means either saving more or saving for longer, but understanding how those variables interact requires income-based information. For example, these questions may help participants consider the levers and require detailed information in income terms:

  • If I increase my savings by 1%, how will that impact my income in retirement?
  • If I want to retire one year earlier, how will that impact my lifestyle in retirement?

Precise information in income terms is vital as participants near retirement.  For example, it’s not enough to tell a participant that they can expect to have income ranging from $30K-$70K. That is probably not going to be useful for that participant to determine whether they can afford to retire next year.  On the other hand, if the estimate ranged from $45K-$55K, this may be much more informative and useful for decision making.  This requires not only information in income terms, but having an investment solution that is managing income uncertainty.

The key difference for an income-focused approach is that the risks that must be considered are related to the uncertainty of future income rather than the volatility of wealth.  Traditional target date funds typically increase fixed income exposure nearing retirement to reduce overall volatility. However, the appropriate risk management asset for an income-focused solution is one that hedges against inflation and interest rate risk and reduces the uncertainty about how much income can be expected in retirement.  The innovation uses inflation-linked bonds matched to the duration of future retirement income liabilities to manage risk of assets for an income-focused solution.

Therefore, a solution focused on income in retirement as the goal should be designed to offer greater exposure to growth assets when an investor is early in their accumulation phase to accelerate wealth accumulation and then over time trade off growth potential for assets that hedge against inflation and changes interest rates to reduce the uncertainty around the level of consumption one’s savings will be able to afford.

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

S&P Dow Jones Indices Quarterly Islamic Market Review

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Michael Orzano

Senior Director, Global Equity Indices

S&P Dow Jones Indices

Most S&P and Dow Jones Islamic indices have outperformed conventional benchmarks through the first half of 2018 driven by underweight to financials.

Most S&P and Dow Jones Shariah compliant benchmarks outperformed their conventional counterparts through the first half of 2018 as financials – which are largely absent from Islamic indices – lagged the market by a wide margin. The strong performance of information
technology and healthcare stocks – which tend to be overrepresented in Islamic indices – also contributed to the outperformance of Islamic benchmarks.

The Dow Jones Islamic Market (DJIM) World and S&P Global BMI Shariah indices rose 1.3% and 1.7% respectively year-to-date (YTD) through the 29th June, outperforming the conventional S&P Global BMI index by about 300bps. A similar trend was seen in all major regions as Shariah compliant benchmarks measuring the US, Europe, Asia Pacific, MENA and emerging markets each outperformed conventional equity benchmarks by meaningful margins.

Emerging markets post steepest losses while the US holds on to gains

In a volatile quarter, emerging market equities experienced steep declines as the US dollar  strength, rising interest rates and trade tensions weighed on investor sentiment. The DJIM Emerging Markets Index lost 4% through the middle of the year – representing the weakest performance among major regions. US equities fared relatively well as strong economic data and corporate profits outweighed concerns over protectionist trade policies. The S&P 500 Shariah gained 3.2% through the 29th June representing the lone major global region in positive territory. Meanwhile, DJIM Europe and DJIM Asia-Pacific declined 2.1% and 1.4% respectively through the middle of the year.

Strength in Saudi Arabia boosts MENA’s equity market performance

MENA equities continued to outperform global markets as the S&P Pan Arab Composite Shariah gained 2.3% in the second quarter (Q2) and 9.3% YTD, driven by rising oil prices and unique strength in Saudi Arabia where equity market reforms and expectations of foreign investor inflows have buoyed markets. The S&P Saudi Arabia rose 6.8% in Q2 pushing the index’s YTD gain to nearly 18%.

This article was first published in Islamic Finance news Volume 15 Issue 28 dated the 11th July 2018.

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

The Importance of Sector Diversification in a Yield-Focused Strategy – Part I

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Qing Li

Director, Global Research & Design

S&P Dow Jones Indices

Diversification is undoubtedly a central tenet of investing. Many studies[1] [2] [3] have shown that over the long-term investment horizon, maintaining a diversified portfolio can potentially reduce overall risk without compromising expected returns. As such, most market participants strive to form diversified portfolios in order to achieve their desired investment outcomes.

There are many ways to achieve diversification within a goal-based portfolio. For example, in a multi-asset portfolio, allocating across various asset classes helps to ensure that returns are uncorrelated and risk is spread across the underlying asset classes. Within the same asset class, diversification can be achieved by investing in various investment styles, investing in international markets, or through cross-sector allocation.

Income-focused strategies can be diversified across multiple fronts—their sources of income (i.e., asset classes and sub-asset classes) as well as sectors from which underlying securities are drawn from. In this series of blogs, we focus on the latter and will demonstrate that incorporating sector diversification in an equity-only, dividend-focused portfolio can help improve the overall risk-adjusted returns of the portfolio.

Using the S&P 500® stocks as the underlying universe, we constructed three hypothetical yield-focused, large-cap strategies with quarterly rebalancing.

  • Strategy 1 consisted of dividend-paying stocks;
  • Strategy 2 consisted of stocks generating positive free cash flows[4]; and
  • Strategy 3 consisted of stocks that exhibited both positive dividend yield and free cash flow yield characteristics.

For each strategy, we ranked securities by their respective characteristics, with the higher values ranking better, and divided them further into five quintiled portfolios. Therefore, the top quintiles of Strategies 1, 2, and 3 were composed of stocks with the highest value of each category. As shown in Exhibit 1, for any given strategy, the top quintile had higher excess returns than the bottom quintile based on quarterly rebalanced data.

We see a clear linear relationship among all of the quintiles for the Free Cash Flow Yield and Dividend Yield + Free Cash Flow Yield strategies; that is, the first quintile portfolio (Q1) had higher excess returns than the second quintile (Q2), Q2 had better returns than the third quintile (Q3), and so on.

However, we did not observe the same pattern of returns for the Dividend Yield strategy.  Here, the Q2 portfolio fared better than Q1. Suspecting that sector bias could be the driving factor, we compared the sector allocation of these two quintiles versus the underlying universe (see Exhibit 2).

Historically, companies in the utilities sector typically pay out high dividends. Therefore, it is not surprising to see that the Q1 Dividend Yield portfolio had a 25% average overweight in the utilities sector relative to the S&P 500. However, this overweight brought a negative effect to the portfolio. Similarly, its average underweight in information technology and financials also detracted from the performance. We observed the opposite for the Q2 portfolio, where those sectors contributed positively.

The attribution analysis shows that sector bias could negatively affect active and overall returns. In part 2 of this blog, we will discuss potential approaches to resolve the undesired sector concentration.

[1]   A. Tabova, “Portfolio Diversification and the Cross-Sectional Distribution of Foreign Investment,” November 2013.

[2]   K. Phylaktis and L. Xia, “The Changing Roles of Industry and Country Effects in the Global Equity Markets,” February 2007.

[3]   S. Cavaglia, C. Brightman, and M. Aked, “On the Increasing Importance of Industry Factors: Implications for Global Portfolio Management,” March 2000.

[4]   Free cash flow is the excess cash that a business has after paying all of the operations and capital expenditures.

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

ESG Strategies on the Rise

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Alka Banerjee

Former Managing Director, Product Management

S&P Dow Jones Indices

Environmental, social, and governance (ESG) risks have taken a strong hold in the developed investing space. Previously, the concept had resided in the domain of “do gooders” and “tree huggers” seeking to make a better world. So what has changed so much that it is now taking root in mainstream investing? By and large, ESG has been able to make the move because of serious concerns backed by legitimate data around environmental degradation worldwide, its impact on humanity, communities, and countries, as well as its economic impact in the form of damage to properties and loss of man hours in the wake of environmental disasters that are coming at a pace not seen before. The damages extend to business activity, leading to loss of revenues and increasing the cost of insurance.

As the thesis around the reining in of environmental damages with a framework of a 2 degree Celsius alignment for climate change has spread, it has behooved large institutional asset owners with large monetary assets at their disposal to become part of the movement. Since no government can afford to finance this mammoth effort alone, it is increasingly apparent that private funding has to step up in innovative ways.

One way is to invest in the funds at their disposal in a manner that sends a message to the corporate world that companies that willfully pollute, feel no sense of corporate citizenship, and do not invest in clean power or processes, which in turn can cause severe environmental damage, will be overlooked when it comes to buying their stock. This process of under investing in or excluding certain types of stocks from investment portfolios has gained popularity in recent times.

Specialized data vendors, like Trucost, a part of S&P Global, measure the carbon footprint of a company to a fair degree of accuracy. This data is then used to create indices or investment portfolios that deliberately underweight polluters and overweight companies that are making an active effort to keep their pollution levels low. This process of penalizing in an investment framework, which keeps the risk/return tracking error for the investor fairly limited, has gained considerable popularity. It is like buying a free option on the carbon penalty. Indices like the S&P Fossil Fuel Free & Carbon Efficient Indices are designed to overweight cleaner companies at the expense of companies with higher emissions within each sector, which means that the risk/return profile of the company matches that of the underlying beta index. Yet, the asset owner is then able to engage companies and send a powerful message that this is an important aspect for them to address. Globally, billions of dollars of institutional asset owner money has moved to carbon efficient indices to indicate strong support for good environmental practices.

For more content related to ESG, dive into ESG on Indexology®.

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

One Big Problem In July For One Small Cap Index

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Jodie Gunzberg

Former Managing Director, Head of U.S. Equities

S&P Dow Jones Indices

Much attention has been drawn to small caps by top tier media since the small cap premium is now the biggest in eight years and the fifth biggest in history. The outperformance of the small cap stocks versus the large caps is being driven by the current economic environment of growth, rising interest rates, inflation and the dollar.  Also, Trump’s tax policy and news around rising tariffs and trade tensions are helping small caps as more of their revenue is generated domestically.

However, it’s not only where in the world small caps generate revenue from that matters, it is that the small caps have earnings.  Just as in the methodology of the S&P 500, the S&P SmallCap 600 has the same financial viability eligibility criteria that states the sum of the most recent four quarters’ as-reported earnings should be positive as should the most recent quarter.  This basic quality rule is vital to earning the small cap premium as discussed here in detail, and shown below where since inception of the S&P 600, only it has outperformed the large caps while the Russell 2000 has performed similarly to both the S&P 500 and Russell 1000:

Source: S&P Dow Jones Indices LLC. Data from June 1, 1995, to Sept. 29, 2017. Index performance
based on total return in USD. Past performance is no guarantee of future results. Chart is provided for
illustrative purposes.

As the media has highlighted small cap performance this year, they are asking more questions and doing deeper analysis on the available small cap indices.  Upon closer inspection of the small cap index choices, they are calling the Russell 2000, “the wrong small cap index.”

Here are two separate examples from articles where this has been published:

SIZING UP SMALL CAPS: A Tale of Two Indexes
Small-cap investors may be measuring their performance against the wrong benchmark
By Brett Arends –  January 27, 2018
Are investors following the wrong small-company stock index?
“The most commonly used benchmark is the Russell 2000, and over 90% of investment funds focusing on U.S. small-cap stocks use it to peg their performance. But for more than two decades, it consistently has done worse than the lesser-known S&P SmallCap 600 index…”

Financial Times
Are you following the wrong small-cap index?
Nicole Bullock in New York  – June 8, 2018
The widely-tracked Russell 2000 has done well, but not as well as a rival benchmark
“Small companies are setting a record pace on Wall Street this year, but many investors are missing out on the cream thanks to a divergence between the two main benchmarks that define the sector for fund managers…”

In addition to the basic earnings screen that has enabled the S&P 600 to deliver the small cap premium through time, there is one more reliable contributor to the S&P 600’s outperformance over the Russell 2000, and it happens in July.  

According to Big Things Come in Small Packages: Looking Into the S&P SmallCap 600 by Gunzberg and Glawe:

The other key methodology difference that drives the outperformance of the S&P SmallCap    600 versus the Russell 2000 is the annual reconstitution effect that dilutes Russell 2000            returns.  It, too, has been well documented, not only in a report by S&P Dow Jones Indices13
showing the significant t-stat of the return difference of the indices, but also by several other well-known 

As winners from the Russell 2000 graduate to the Russell 1000, and losers from the Russell 1000 move down to the small-cap index, fund managers are forced to sell winners and buy losers, thereby creating a negative momentum portfolio.14   Jankovskis15 and Chen, Noronha, and Singal16 estimated that the predictable nature of the June Russell rebalancing process biases the return of the index downward by an average of approximately 2% per year. Similarly, Chen, Noronha, and Singal found the rebalancing impact to be 1.3% per year.

Source: S&P Dow Jones Indices LLC, Russell, FactSet. Data from 1994 through 2016. Past
performance is no guarantee of future results. Chart is provided for illustrative purposes and reflects
hypothetical historical performance. Please see the Performance Disclosure at the end of this
document for more information regarding the inherent limitations associated with back-tested

Together, quality and reconstitution account for most of the S&P SmallCap 600’s outperformance over the Russell 2000. Some of the return difference may also be associated with the liquidity criterion of the S&P SmallCap 600 that is not applied to the Russell 2000. Within the S&P SmallCap 600, a small percentage of stocks, roughly 3%, have a three-month average daily trading volume (ADVT) of less than USD 1 million, compared with about 15% of stocks in the Russell 2000 that have a three-month ADVT of less than USD 1 million. (2017, pp. 13-14)


13 Brzenk, P. and A. Soe, (2015), “A Tale of Two Benchmarks: Five Years Later,” S&P Dow Jones Indices.
14 Furey, James H., (2001), “Russell 2000 Bigger but not better benchmark.”
15 Jankovskis, Peter, (2002), “The Impact of Russell 2000 Rebalancing on Small-Cap Performance.”
16 Chen, Honghui, Greg Noronha, and Vijay Singal, (2006), “Index Changes and Losses to Investors in S&P 500 and Russell 2000 Index Funds.”

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