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Latin American Scorecard: Q2 2018

The S&P 500 Equal Weight Index: A Supplementary Benchmark for Large-Cap Managers’ Performance – Part I

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

Latin American Scorecard: Q2 2018

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Silvia Kitchener

Director, Global Equity Indices, Latin America

S&P Dow Jones Indices

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Q2 2018 showed that volatility is king in Latin America. The first quarter saw strong returns for the region, with Mexico lagging. In the second quarter, we saw a practical wipeout of all gains for the year and a return to negative territory for Latin America. Recent presidential elections in Mexico and Colombia, as well as upcoming elections in Brazil brought economic uncertainty. Brazil, the largest market in the region, had a significantly tough second quarter. During this period, the country saw great currency depreciation, climbing inflation rates, as well as fiscal and political challenges that largely contributed to the region’s plunge. For the quarter, the S&P Brazil BMI was down 26% in U.S. dollar terms, while the regional S&P Latin America BMI and S&P Latin America 40 were down 18% and 19%, respectively.

It is indisputable that Latin America is going through major upheavals. However, in terms of indices, one of the factors with the biggest impact is currency fluctuations. All the local and regional indices saw sharp drops in performance when looking at U.S. dollar returns, while local investors saw a different picture of the region. A good example is the S&P MILA Pacific Alliance Composite, which excludes Brazil. The broad region of 141 stocks saw returns of -5% in USD for the quarter, but in Chilean and Mexican pesos, the returns were positive, up 2.7% and 2.5%, respectively. In Colombian pesos, the index was flat at 0.1% and in Peruvian nuevos soles, it was down 3%. This shows that, depending on where you are, currency plays an important part in index performance.

Despite the underperformance, there were some strong positive returns, particularly in Mexico and Colombia. The S&P/BMV IPC and S&P Colombia Select displayed strong performance in local currency terms, generating returns of 4.4% and 10.4%, respectively. Other pockets of positive returns were in the energy sector of the Pacific Alliance region,[1] which returned nearly 4% for the quarter and 64% for the year ending June 2018 in U.S. dollar terms.

Volatility is the name of the game in Latin America, and it will be interesting to see what happens next quarter. So far, the presidential elections in Mexico have barely had any impact on the market, and in the first week of July, Brazil has come back to positive territory, but there are many weeks still ahead before the next quarter—stay tuned.

To see more details about performance in Latin America, please see: S&P Latin America Equity Indices Quantitative Analysis Q2 2018.

[1] The Pacific Alliance region includes Chile, Colombia, Mexico, and Peru.

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

The S&P 500 Equal Weight Index: A Supplementary Benchmark for Large-Cap Managers’ Performance – Part I

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Aye Soe

Managing Director, Global Head of Product Management

S&P Dow Jones Indices

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In January 2003, S&P Dow Jones Indices introduced the world’s first equal-weighted index, the S&P 500® Equal Weight Index, leading the way for the subsequent development of non-market-cap weighted indices.[1] Since then, looking at the index’s historical back-tested performance, it outperformed its market-cap-weighted counterpart, the S&P 500, in 16 out of 28 years, with an annualized excess return of 1.44% per year.[2]

In addition to better relative performance, equal weighting can have fundamental appeal for market participants who subscribe to the notion that market-cap weighting exhibits momentum bias, with winners getting a larger weight in the index, and potentially leading to concentration and overvaluation issues. Therefore, for those who wish to reduce concentration risk or to separate the price of a security from its fundamentals, an equal-weight index can offer an alternative approach.

Moreover, equal-weight indexing could hit closer to home for proponents of passive indexing, given that its investment underpinning runs counter to active investing. While active management seeks to exploit risk and return expectations of securities through a superior selection process and diversified portfolio construction, equal-weight indexing assumes that all the securities in the universe have the same expected returns and volatility. In other words, by equal weighting, we assume that an average investor has no forecasting ability or is unable to distinguish securities’ returns and volatilities.

Therefore, one can argue that the lack of return, risk, and covariance matrix assumptions in an equal-weighted index makes it a natural benchmark against actively managed funds that incorporate all those expectations. In fact, several studies have shown that an alpha-generating strategy should be able to outperform an equal-weight benchmark.[3]

Against that backdrop, we compare the performance of actively managed U.S. large-cap and large-cap core funds with the S&P 500 Equal Weight Index (see Exhibits 1 and 2) as of March 31, 2018.[4] As we can see below, over the near-term horizons (one, three, and five years), a higher percentage of large-cap funds underperformed the S&P 500 than the S&P 500 Equal Weight Index, primarily due to mega-cap securities performing well in the large-cap space and contributing significantly to the S&P 500 returns over the past two years.

However, over the long-term investment horizons (10 or 15 years), a greater percentage of large-cap funds underperformed the S&P 500 Equal Weight Index than the S&P 500. In fact, the 15-year figures paint a difficult landscape in which close to 100% of large-cap managers underperformed the S&P 500 Equal Weight Index.

Our analysis shows that the S&P 500 Equal Weight Index set a higher threshold for managers to outperform in the long run. In a subsequent blog, we will look at the underlying risk factor exposures of the S&P 500 Equal Weight Index and present a framework in which the index can serve as a supplementary benchmark to evaluate large-cap managers.

[1]   Zeng, L. and Luo, F. “10 Years Later: Where in the World is Equal Weight Indexing Now?” S&P Dow Jones Indices LLC. April 2013.

[2]   Calendar year returns were calculated from 1990 through 2017. Annualized excess returns were computed from Jan. 31, 1990, to May 31, 2018. Past performance is no guarantee of future results. Hypothetical performance is used.

[3]   Edwards, T. and Lazzara, C. “Equal-Weight Benchmarking: Raising the Monkey Bars.” S&P Dow Jones Indices LLC. May 2014.

[4]   For our analysis, the underlying data source was the University of Chicago’s Center for Research in Security Prices (CRSP) Survivorship-Bias-Free US Mutual Fund Database, which is the same source used by the headline SPIVA® U.S. Scorecard.

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

Setting Income Goals For A Winning Retirement

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Jodie Gunzberg

Managing Director, Head of U.S. Equities

S&P Dow Jones Indices

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“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

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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

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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.