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Momentum for a Low-Carbon Economy – A Postcard From Poland

Passive Investing Opportunities in India

Performance Attribution of the S&P 500® Quality Index

Brexit: Sell on May and Run Away?

Let’s talk about Communication

Momentum for a Low-Carbon Economy – A Postcard From Poland

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Hannah Skeates

Former Senior Director, ESG Indices

S&P Dow Jones Indices

It is now three years since the historic events at the UN Climate Conference in Paris in December 2015. At that event, with much relief and emotion, the countries of the world came together to agree that global emissions should be limited. We would collectively seek to contain the temperature rise to within 2 degrees Celsius from pre-industrial levels—thereby hopefully avoiding the worst implications of catastrophic climate change.

In the past three years, we have experienced ever more obvious changes to our physical climate across the world. Dramatic weather events are hitting frequently, whether storms or water shortages. In addition to the climate change effects of greenhouse gases, our increasing global urbanization, combined with reliance on fossil fuels, has created many pollution hotspots that are socially unsustainable. Furthermore, the Intergovernmental Panel on Climate Change has recently suggested that 2 degrees is not low enough—we need to aim for a rise of just 1.5 degrees.[1]

So here at COP24, the UN’s 2018 climate talks taking place in Katowice, Poland from Dec. 3-14, 2018, the focus is on how to get on track to a low- (or zero-) carbon economy. For this to happen, emissions must peak rapidly and then reduce. Information must be available to investors so that they can make climate-conscious decisions about how they allocate their capital—aware of the goal and aware of the transition-related risks and opportunities.

While the speed of change may not yet be fast enough, action is being taken. Ireland is removing its high-carbon investments via its Fossil Fuel Divestment Bill.[2] South Africa has introduced a carbon tax bill that notes “the costs of remedying pollution, environmental degradation and consequent adverse health effects … must be paid for by those responsible for harming the environment (the polluter pays principle),”[3] and the European Commission has called for a climate-neutral Europe by 2050, with a strategy based on “investing into realistic technological solutions, empowering citizens, and aligning action in key areas such as industrial policy, finance, or research – while ensuring social fairness for a just transition.”[4] Energy companies themselves have started to make significant announcements about their emissions-reducing intentions; Royal Dutch Shell and Xcel Energy have both stated new carbon targets since the UN conference began.

These types of structural changes have direct implications for investors. Many large asset owners have long been aware of the need to align their portfolios with their beneficiaries’ long-term interests, and now these implications are reverberating in asset management and in the banking industry at large.

The world’s largest pension fund, the Government Pension Investment Fund for Japan (GPIF), recently selected two new S&P Carbon Efficient Indices to serve as benchmarks within their ESG investment strategy.[5] These indices sit alongside other carbon-related ones, such as the S&P Fossil Fuel Free Indices or the S&P Carbon Price Risk Adjusted Indices, which integrate the potential risk of future carbon pricing on companies’ possible future market value.

Back in Poland, and according to a recent UN Emissions Gap report,[6] the trajectory could still imply a 3.4°C temperature rise this century—something that the conversations happening in Katowice are looking to change, and fast.







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

Passive Investing Opportunities in India

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Akash Jain

Director, Global Research & Design

S&P BSE Indices

Fifty years ago, there were no index funds—all assets were managed actively. The subsequent shift of assets from active to passive management in the U.S. and European markets could be considered one of the most important developments in modern financial history, and this shift was the consequence of active performance shortfalls.[1] In India, we have seen similar shortfalls, coupled with unique local factors that have contributed to the rapid growth of passive investments in the Indian mutual fund industry.


Lower cost has been the simplest explanation for the success of passive management. Active managers’ costs—for research, trading, management fees, etc.—have tended to be inherently higher than those of passive managers.[2] By investing via the passive route, investors can potentially save 100 bps in management fees.[3]

Increased Regulatory Oversight, Government Initiatives, and Evolving Market Microstructure

The Securities and Exchange Board of India (SEBI) introduced style and size definitions and mandated that mutual funds only manage one product offering in each style category,[4] aiming to bring standardization across the industry. SEBI also required equity fund managers to benchmark performances against total return indices (TRI).[5] Some of the other milestones include investment by the Employees’ Provident Fund Organization (EPFO) into large-cap ETFs[6] and divestment by the Department of Investment and Public Asset Management (DIPAM) since 2013, which helped to raise approximately INR 340 billion via multiple tranches among different ETFs.[7]

Real-World Returns Are Positively Skewed

The skewness of stock returns is often an underappreciated element in the performance difficulties of active managers. The intuition is simple: a manager’s picks are more likely to underperform than to outperform simply because there are more underperformers than outperformers from which to choose.[8] Active managers in India, like their U.S. counterparts, are challenged by a positively skewed equity market.

Growth of the Domestic Mutual Fund Industry

AUM/GDP is a commonly used ratio to track the penetration of mutual funds in an economy. Exhibit 1 illustrates that India (7%) has a long way to go before it reaches the stature and depth of the U.S. (91%) market. As the Indian economy matures and financial literacy improves, one could anticipate higher adoption rates of mutual fund products as a long-term savings tool. This has the potential to expand the overall size of the mutual fund industry and simultaneously raise passive investment shares.

In the U.S., the passive share of the equity mutual fund and ETF assets was approximately 45% as of the end of 2017, more than double its 20% level at the beginning of 2007.[9] In contrast, India’s share was just 3.8% as of March 2018.[10] Although India’s passive share is small, India is beginning to consider the benefits of passive investing, similar to the U.S. market during the 1970s. The Indian passive market has the potential to mirror the growth seen in the U.S., as Indian investors take note of the benefits from lessons in passive investing in developed markets and start to enable wealth creation through transparent, systematic, style-consistent, and low-cost, index-linked products.

[1]   Ganti, Anu R. and Craig J. Lazzara, “Shooting the Messenger,” S&P Dow Jones Indices, December 2017.

[2]   Sharpe, William F., “The Arithmetic of Active Management,” The Financial Analysts’ Journal, Vol. 47, No. 1, January/February 1991, pp. 7-9.

[3]   Ganti, Anu R. and Jain, Akash, “A Glimpse of the Future: India’s Potential in Passive Investing,” S&P Dow Jones Indices, November 2018.

[4]   Categorization and Rationalization of Mutual Fund Schemes, SEBI Circular SEBI/HO/IMD/DF3/CIR/P/2017/114, Oct. 6, 2017.

[5]   Benchmarking of Scheme’s performance to Total Return Index, SEBI Circular SEBI/HO/IMD/DF3/CIR/P/2018/04, Jan. 4, 2018.

[6]   “EPFO invested nearly Rs 50K cr in ETFs till June 30: Govt,” The Times of India, July 18, 2018.

[7]   Recent Disinvestment, Department of Investment and Public Asset Management, Financial Year 2018-19.

[8]   The challenge for stock pickers is exacerbated when the outperformers include the largest stocks in the index. See Chan, Fei Mei and Craig J. Lazzara, “Degrees of Difficulty: Indications of Active Success,” S&P Dow Jones Indices, May 2018, pp. 8-9.

[9]   Whyte, Amy, “Passive Investing Rises Still Higher, Morningstar Says,” Institutional Investor, May 21, 2018.

[10]Digital evolution,” CRISIL, August 2018. The 4% passive share is approximately 90% in equity ETFs, with the remainder in index funds and gold, liquid, and debt ETFs.

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

Performance Attribution of the S&P 500® Quality Index

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Wenli Bill Hao

Director, Factors and Dividends Indices, Product Management and Development

S&P Dow Jones Indices

The past two months saw bouts of market volatility, which in turn is causing market participants to refocus on defensive equity strategies. Quality, together with other defensive factors such as low volatility, has a higher degree of downside protection compared with other risk factors like value or momentum. For example, during months in which the returns of the S&P 500 are negative, the quality factor has higher returns than the benchmark about 75% of the time (see Exhibit 1).

As such, we examine the long-term performance of the S&P 500 Quality Index to understand the underlying sources of the excess returns. To do so, we look at the security selection criteria of the S&P Quality Indices.

The S&P Quality Index Series uses a company’s overall quality scores for security selection. The overall quality score is composed of three fundamental ratios: balance sheet accruals ratio (BSA), return on equity (ROE), and financial leverage ratio (leverage).[1]

To understand the performance sources of the S&P 500 Quality Index, we dissect the index performance into three components: the S&P 500 Quality BSA Attribution, S&P 500 Quality Leverage Attribution, and S&P 500 Quality ROE Attribution.[2] Assuming a starting value of 100 on June 30, 1995, Exhibit 2 shows the cumulative values of the S&P 500 Quality Index and its three attribution components from June 30, 1995, to Nov. 30, 2018.

In Exhibit 2, we can observe that the BSA factor has had the highest cumulative returns among the three factors, followed by ROE and leverage. In fact, in recent periods, the performance of the BSA has surpassed that of the S&P 500 Quality Index. However, cumulative return is just one dimension in the performance evaluation of a factor. Risk, as measured by standard deviation, is another dimension worth looking into in order to better understand a strategy or a factor’s return/risk profile (see Exhibit 3).

According to Exhibit 3, the integrated portfolio, as represented by the S&P 500 Quality Index, had the highest return/risk ratio when compared with the underlying component indices. This finding is not surprising given the potential diversification benefits of its subcomponents when combined in a portfolio context. The return correlations of the S&P 500 Quality Index and its components are fairly high, but not perfectly correlated (see Exhibit 4).

Market volatility has a way of making investors rethink defensive equity strategies. The S&P 500 Quality Index, with a high hit rate of 75% during down months, is a factor that has historically had a higher degree of downside protection compared with riskier factor strategies. Among its three subcomponents, the attribution analysis shows that the BSA factor has had the highest cumulative returns, followed by ROE and leverage. The potential diversification benefits of its subcomponents attributed to the integrated S&P 500 Quality Index having the highest return/risk ratio when compared with the underlying component indices.

[1]   The detailed factor definition and index construction are laid out in the S&P Quality Indices Methodology.

[2] S&P 500 Quality BSA Attribution. Securities in the eligible universe are selected for index inclusion based on their accruals ratio z-score determined during the semiannual rebalancing of the S&P 500 Quality Index. The values for all securities are ranked in ascending order.

S&P 500 Quality Leverage Attribution. Securities in the eligible universe are selected for index inclusion based on their financial leverage ratio z-score determined during the semiannual rebalancing of the S&P 500 Quality Index. The values for all securities are ranked in ascending order.

S&P 500 Quality ROE Attribution. Securities in the eligible universe are selected for index inclusion based on their return-on-equity z-score determined during the semiannual rebalancing of the S&P 500 Quality Index. The values for all securities are ranked in ascending order.

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

Brexit: Sell on May and Run Away?

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Chris Bennett

Former Director, Index Investment Strategy

S&P Dow Jones Indices

29 months after the referendum that triggered Britain’s departure from the E.U., and a little over four months from the scheduled departure date, the nature of the ultimate exit deal (if any) remains uncertain. What can indices tell us about the market’s reaction and expectations?

The volatility of the pound sterling has offered a direct link to the uncertainty faced by market participants. And with a parliamentary vote on the proposed terms of Britain’s withdrawal expected on December 11th, the CBOE/CME FX British Pound Volatility index (BPVIX) has risen to its highest levels since the referendum.

UK equities tell a similar story; the S&P U.K. Focused Domestic Revenue Exposure Index and S&P U.K. Focused Foreign Revenue Exposure Index were designed to measure the performance of UK companies with primarily domestic and primarily foreign revenues, respectively. Comparing these indices provides a better understanding of how the markets believe companies in the UK will fare. Exhibit 2 compares their performance since the beginning of 2016. (The Brexit referendum was held on June 23, 2016.)

Through Dec. 3, 2018, UK companies with primarily foreign revenue exposure had gained 14% since the Brexit referendum, while UK companies with primarily domestic revenue exposure had lost 21%. For those counting, that’s a 35% return spread.

Part (but not all) of this decline may be attributed to currency movements. The pound sterling’s relative decline against the U.S. dollar and other major currencies has elevated the value of foreign earnings to companies that have them. Currency cannot take all of the blame, however. Another driver of the decline could be an expectation that UK domestic consumer demand will decline (or at least not grow as fast) as equivalent demand from those abroad.

Safety among British equities may lie in shiny objects. Sectors with greater exposure to commodities have weathered the Brexit storm admirably, particularly the Materials sector, which is up 76% since the referendum. On a more granular level, the Metals & Mining Industry has done particularly well (up 93% since the referendum).

Of course, circumstances can change quickly. The present situation has reminded some commentators of the final quarter of 2008 when, considering a politically divisive “bail out” to stave off financial collapse, the U.S. Congress initially voted against a rescue package. On the day the results become clear, the Dow plunged by over 7%. Shortly thereafter, Congress reversed its initial decision. Whether the UK political establishment will be as sensitive to the market’s concerns, and which scenarios are already “priced in”, remains to be seen. Until then, the indices highlighted in Exhibits 2 and 3 could indicate which way the winds are currently blowing, and where shelter might be found in a storm.

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

Let’s talk about Communication

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Hamish Preston

Head of U.S. Equities

S&P Dow Jones Indices

One of the largest ever changes to the Global Industry Classification Standard (GICS®) went into effect prior to the open on Monday 24th September, affecting around 10% of the S&P 500’s market capitalization.  In case you missed our previous announcements, here is a brief explanation of GICS, what changed, and why these changes went into effect.

What is GICS?  The Global Industry Classification Standard was created in 1999 to unify definitions about different market segments.  GICS assigns each company to one of the 158 (157 before September 24th) possible sub-industries, which then determine – in decreasing order of granularity – one of 68 possible industries, one of 24 possible industry groups, and one of 11 possible sectors.

Exhibit 1: GICS Hierarchy

What changed?  The GICS update involved expanding the Telecommunication Services sector to include some constituents from the Consumer Discretionary and Information Technology sectors.  Exhibit 2 shows the composition of the resulting sector, now named Communication Services, for large-cap U.S. companies (the area for each constituent is proportional to its weight in the sector).  You’ll notice a number of the so-called FAANGs are constituents.

Exhibit 2: Many FAANGs are constituents of the S&P 500 Communication Services sector

Why did these changes happen?  The manner in which people, businesses, and communities communicate has changed dramatically.  These developments didn’t occur overnight but they do mean that communications is now far broader than telecoms.  The chairman of our Index Committee, David Blitzer, provided greater clarity on the thinking behind the sector in a prior post.  Here is one of his charts.

Exhibit 3: The way we communicate has changed over time

Have similar changes happened before?  Yes, the last GICS update occurred in September 2016 when Real Estate became a stand-alone sector (previously, it was part of Financials).  More broadly, the GICS changes recognize only the latest evolution (or revolution) in the industries that compose our markets and economies.  As we highlighted in a recent paper, the first industrial revolution was associated with Railroads – hugely important in 1900 and accounting for more than 50% of the U.S. equity market.  The second industrial revolution was associated with mechanization of manufacturing; the Manufacturing sector dominated U.S. equities by 1950.

Exhibit 4: Sector changes reflect the evolution in industries that compose our markets

The recent updates to GICS reflect changes to the way we communicate, and the sensitivities (especially to advertising revenues) that these communications companies share.  Remembering these sensitivities may be particularly useful for market participants looking to understand the performance of communications companies: concerns over declining ad revenue growth contributed to many investors being bitten by the FAANGs during the recent bout of market volatility.

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