Indexology^® Blog

One of the most persistent trends over the last decade has been the underperformance of value compared to growth.  The S&P 500 Growth beat its Value counterpart in eight of the last ten full calendar years, and growth is currently on track to outperform in 2018 (you can find year-to-date figures on page four of our daily dashboard).

Exhibit 1: Growth has outperformed over the last decade

Although the trend remains intact so far in 2018, a recent uptick in volatility left many investors wondering if value might be in line for a comeback.  Indeed, value outperformed in October and November as many growth-oriented stocks came under pressure from investors looking to take risk off the table.  While it remains to be seen if this nascent trend is here to stay, historical sector exposures may be useful for assessing the relative prospects of growth and value.

Exhibit 2 shows that Financials and Tech were usually the largest sectors in the value and growth indices, respectively.  This result held across all three time frames, capturing 1) the run-up to the height of the Tech bubble (Jan. 1995 to Mar. 2000); 2) the subsequent bursting of that bubble and the run-up to the Global Financial Crisis (Apr. 2000 to Dec. 2007); and 3) the Global Financial Crisis and the most recent bull market in U.S. equities (Jan. 2008 to Nov. 2018).

Exhibit 2: Average Sector Weights in the S&P 500 Value and S&P 500 Growth

Given their large weights in the factor-based indices, it is perhaps unsurprising that the contributions to returns from Financials and Tech were important for understanding the performance of value and growth.  For example, Tech contributed most positively to the S&P 500 Growth in the most recent period and in run-up to the height of the Tech Bubble, but it weighed most heavily as the bubble burst.  Similarly, Financials was the largest contributor to the S&P 500 Value in the late 1990s and early 2000s, but has been the biggest drag on the value index since the start of 2008.

As a result, there has been much discussion (including in one of our recent videos) about whether the last couple of months represent a style shift in U.S. equities.  While it remains to be seen if value is in line for a comeback, history suggests that the (expected) performance of the Tech and Financials sectors could be useful considerations when trying to predict how these styles may perform.

On Nov. 26, 2018, S&P Dow Jones Indices (S&P DJI) launched the S&P GSCI Iron Ore and the S&P GSCI Industrial Metals & Iron Ore Equal Weight to provide investors exposure to one of the most important industrial commodities in the world. Iron ore is the second-largest commodity market by value after crude oil and is a major industrial component of the world’s second-largest economy, China. The S&P GSCI Iron Ore is benchmarked to the SGX TSI Iron Ore CFR China (62% Fe Fines) Index Futures. The Singapore Exchange (SGX) is the home of international iron ore derivatives, offering Iron Ore CFR China (62% Fe Fines) swaps, futures, and options.

Offering investors an index benchmarked to an iron ore futures contract provides insight into the steel market, as iron ore is the primary raw material used in the production of steel, which is the key material used in construction, ship building, and other heavy manufacturing activities. China has the world’s largest steel industry and is the main importing nation for global seaborne iron ore. China’s crude steel production is forecast to reach a new annual record of 923 million metric tons in 2018,[1] despite ongoing anti-pollution measures to shut down low-grade steel capacity and the ever-evolving China-U.S. trade war. Major iron ore producing countries include Australia and Brazil, where iron ore production and prices can have a significant impact on economic growth, terms of trade, and local currency fluctuations. The introduction of the S&P GSCI Iron Ore and S&P GSCI Industrial Metals & Iron Ore Equal Weight opens up this investment universe to global investors.

Exhibit 1 depicts the summary statistics of the performance of iron ore compared with the commodities included in the industrial metals sectors.

While iron ore is defined as an industrial metal according to S&P DJI’s commodity sector definition, the futures contracts behind the other industrial metals indices are for processed or semi-processed metals, while the iron ore contract refers to a raw material. Looking at the three- and five-year returns of the industrial metals commodities, iron ore was the best-performing commodity on a three-year annualized and risk-adjusted return basis, and the second-best performing commodity on a five-year basis after zinc. In terms of correlation, the ferrous metal exhibited the lowest correlation among the industrial metals.

[1]   China Metallurgical Industry Planning and Research Institute.

2018 marks the 40^th anniversary of the S&P/BMV IPC, launched on Oct. 30, 1978, as part of the Mexican market revolution. Honoring that milestone, we revisited the evolution of the index that has since become an icon of the Mexican equity market.[1]

As of Dec. 31, 2017, Mexico had 141 listed domestic companies, with a market capitalization representing roughly 36.26% of the Mexican gross domestic product (GDP).^[2] The 35 constituents of the S&P/BMV IPC amounted to approximately USD 295,450 million[3] in market capitalization, capturing nearly 70.61% of the listed equity market.

The S&P/BMV IPC has represented a sizable portion of the Mexican economy, as measured by the GDP (see Exhibit 1). From 1978 to 2017, the average market capitalization of listed domestic companies accounted for about 22% of the country’s GDP, reaching a maximum of 44.24% in 2012.

The main objective of the S&P/BMV IPC is to measure the performance of the largest and most liquid stocks listed on the Bolsa Mexicana de Valores (BMV). Based on historical 10-year figures, the S&P/BMV IPC captured about 80% of the market capitalization on average. Exhibit 2 shows a comparison of the market capitalization of the constituents of the S&P/BMV IPC versus the S&P Mexico BMI (MXN), which is another broad-based benchmark from the S&P BMI Series and is designed to measure the performance of the Mexican equity market.

During the past four decades, the S&P/BMV IPC has played an important role, serving as a barometer for the Mexican capital market. Since its launch, the structure and characteristics of the index have evolved gradually, while keeping the primary objective of measuring the performance of the largest and most liquid stocks listed on the BMV. In subsequent blog posts, we will explore its evolution in greater depth.

[1]   For more information, see The S&P/BMV IPC Turns 40.

[2]   World Development Indicators Database Archives as of Nov. 14, 2018.

[3]   Using the foreign exchange rate in U.S. dollars against Mexican pesos, disclosed by the World Federation of Exchanges.

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.

[1]   https://unfccc.int/process-and-meetings/the-paris-agreement/the-paris-agreement

[2]   https://www.oireachtas.ie/en/bills/bill/2016/103/

[3]  http://www.treasury.gov.za/public%20comments/CarbonTaxBll2017/Draft%20Carbon%20Tax%20Bill%20December%202017.pdf

[4]   https://ec.europa.eu/clima/policies/strategies/2050_en

[5]   https://www.prnewswire.com/news-releases/gpif-worlds-largest-pension-fund-selects-new-environmental-indices-launched-by-sp-dow-jones-indices-300718033.html

[6]   https://www.unenvironment.org/resources/emissions-gap-report-2018

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.

Cost

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.