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Pure Style Indices: A Finer Tool With Higher Style Focus

Looking at Sectors With a Style Lens

Raising the Bar in Small Caps

S&P 500 Has Its Hottest Start Since 2003

Watching For Recession

Pure Style Indices: A Finer Tool With Higher Style Focus

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Aye Soe

Managing Director, Global Head of Product Management

S&P Dow Jones Indices

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Style investing as an investment approach has long been utilized by market participants to group securities based on their common characteristics and risk/return drivers. Those common characteristics, in turn, help investors make strategic and tactical asset allocation decisions.

The first-generation S&P U.S. Style Indices serve as effective underlying tools for market participants seeking a passive investment vehicle or benchmarks measuring active style portfolios. Covering broad market segments, the indices group the universe into value and growth categories using style metrics commonly used in the investment community.

Certain securities may exhibit both growth and value characteristics: in this scenario, the company’s market capitalization is distributed between growth and value indices. This makes the indices suitable for those seeking a traditional “buy and hold” index-linked investment implementation with a tilt toward a particular style.

A side effect of this is that there are overlapping securities that fall into both growth and value indices. This mixed basket approach may not appeal to market participants that desire more precise and focused measurement tools.

The S&P Pure Style Indices were created with a stricter definition of style factors, resulting in a clearer differentiation between growth and value. The two approaches to differentiating between value and growth are highlighted in Exhibit 1 using the S&P 500® and the large-cap style (S&P 500 Value and S&P 500 Growth) and pure style indices (S&P 500 Pure Value and S&P 500 Pure Growth) as an example.

 The S&P Pure Style Indices include only securities that exhibit either pure growth or pure value characteristics. Due to this, there are no overlapping securities between the pure growth and pure value indices. The concentrated exposures of the S&P Pure Style Indices potentially present them as better candidates for market participants looking to have precise tools in their investment process.

These differences drive the long-term performance differential between the two sets of indices, giving rise to distinct risk/return profiles. We report the risk/return differences between the style and pure style indices in Exhibits 2 and 3. For comparison purposes, we include the Russell Style indices, given that market participants also benchmark to those indices.

The pure style indices had higher average returns than the style indices; however, they also exhibited higher volatility, evidenced by the average annual volatility figures. The return/risk ratio shows that pure style displayed mixed performance results depending on the market-cap size, style orientation, and measurement period.

Both style and pure style indices use the same fundamental metrics to calculate style scores and to group securities into value and growth categories. Additionally, the pure style indices use style scores to determine constituent weights. Therefore, we expect the pure style indices to have stronger value or growth characteristics than their style peers. Exhibit 4 shows the annual averages of these ratios, which mostly line up with our expectations.

Across all size segments, the pure value indices historically had more attractive, or lower, price multiples than both the value indices and the underlying benchmarks. Interestingly, the pure growth indices tended to have lower valuation multiples than their traditional growth counterparts. A potential cause may be due to the higher sales and earnings growth rates of the pure growth indices versus the growth indices, outweighing the price difference.

For a deeper dive into the next generation of style indices, tune into our webinar at 2pm EST tomorrow: Sizing Up Your Style Strategies.

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

Looking at Sectors With a Style Lens

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Anu Ganti

Senior Director, Index Investment Strategy

S&P Dow Jones Indices

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We’ve previously observed that we can view the world through both a factor and a sector lens, but what about overlaying sectors and style? This is indeed possible, as sectors can serve as implementation vehicles to achieve a particular view on style.

Using value and growth scores that are reset annually for every constituent within the S&P Total Market Index, Exhibit 1 plots the 11 S&P 500® GICS® sectors on the value versus growth spectrum, calculated as an index-weighted average score at the sector level. The size of the bubbles is proportional to the market cap of the sectors. For example, Information Technology is the biggest bubble, as it has the largest index market cap among sectors (and it also has the lowest value score). Meanwhile, Financials, the third-largest sector by market cap, has the highest value score along with the second-highest growth score.

Investors looking to access value and growth can do so through sectors such as Energy and Financials (the far right side of Exhibit 1). Meanwhile, for those who seek to take a more singular growth bet, the new Communication Services sector is a natural option.

We can similarly apply a style lens across industries. Exhibit 2 shows that high value exposure is prevalent in Insurance and Metals & Mining, while we observe a greater growth tilt for Oil & Gas Exploration & Production and Healthcare Equipment.

Investors can achieve style exposures through sectors and industries, and it is useful to understand how these dimensions interact with each other.

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

Raising the Bar in Small Caps

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Chris Bennett

Director, Index Investment Strategy

S&P Dow Jones Indices

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As a leading index provider with clients and customers around the world, S&P Dow Jones Indices regularly launches new indices.  Just like our children, we try to love them all equally.  Every now and then, however, a particularly exciting new index comes along.  Last week, our global equities group launched a potentially important new benchmark for global small cap investors, the S&P Global SmallCap Select Index Series.  This series is built on the basic principle that filtering out junk makes a big difference in small caps, and extends this concept globally.

Who needs earnings?  Contrary to the rumblings out of Silicon Valley, profitability is not a bad thing.  With small companies, earnings may be particularly important to long term returns, and trimming out poor performers can substantially improve investment performance in small cap portfolios.  For example, the S&P SmallCap 600®—which includes positive earnings criteria—has outperformed the broader Russell 2000 Index (with lower volatility) for more than 20 years.  This outperformance has been examined in some detail by earlier S&P DJI research, but this is the first time that S&P DJI has extended the concept in a consistent way to the global small-cap universe.

The S&P Global SmallCap Index (representing the portion of the S&P Global BMI made up from the smallest 15% of companies in each country by capitalization) provides the starting point for the “Select” series.  In order to become a member of the Select, companies must meet additional size and liquidity criteria, and must also post two consecutive years of positive earnings.  Around 5,000 of the 8,321 global small cap companies, accounting for around 4/5ths of the free-float market capitalization, were included in the Select index at the most recent rebalance.

The potential benefit of the methodology is demonstrated in the chart below, where we see consistent excess returns from the SmallCap Select series vs. its parents.  On a rolling five-year basis, for both the Global and Global Ex-U.S. versions of the small cap indices, the Select index outperformed most of the time, averaging around 1% per annum in excess returns.  A simple profitability screen, in other words, would have generated substantial excess returns relative to the unscreened small cap universe.

The series offers a global index as well as regional indices which can be further broken into country indices as needed.  Currently, the universe includes:

  1. S&P Global SmallCap Select Index
  2. S&P Global ex-U.S. SmallCap Select Index
  3. S&P Developed ex-U.S. SmallCap Select Index
  4. S&P Emerging SmallCap Select Index
  5. S&P/ASX Small Ordinaries Select Index

These indices could change the game for global small-cap investing and for benchmarking the performance of active small cap portfolios.  Those who take the time to look could discover a way to improve results in small caps.

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

S&P 500 Has Its Hottest Start Since 2003

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Jodie Gunzberg

Managing Director, Head of U.S. Equities

S&P Dow Jones Indices

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In the first seven trading days of 2019, the S&P 500 returned 3.6%, its 12th best start on record since 1928 and best since 2003.  Also, the S&P MidCap 400 and S&P SmallCap 600 surpassed large caps by posting their best gains ever to start a year.  Lastly, more than half the segments by sector, size and style have posted their biggest gains in history.

Source: S&P Dow Jones Indices

The S&P 500 posted five consecutively positive days, ending January 10, 2019, returning a total of 6.1%.  The last time the S&P 500 returned five consecutively positive days was ending September 14, 2018, but the cumulative return was just 1.2% then.  Five straight days of positive returns has happened 4% of the time since January 4, 1928, but in just 44 prior instances or 0.2% of the time, has the return been bigger than now.  The last time the five day return (with all positive days) was bigger than 6.1% happened in the streak ending July 13, 2010, returning 6.5%.  The last January that had a five day winning streak this big happened in January 1987 that occurred in the first five trading days of that year and returned 6.2%.

Source: S&P Dow Jones Indices.

Across all the size, style and sector segments, 22 of 42 total posted their best start to any year in the first seven trading days.  The S&P SmallCap 600 and S&P MidCap 400 each posted their best start in history, gaining a respective 6.4% and 5.9% with value outperforming growth.  Eight of eleven small cap sectors, six of eleven mid-cap sectors, and just two of eleven large cap sectors started strongest this year. Energy and consumer discretionary each had their best start despite size.

Source: S&P Dow Jones Indices

The leading sectors may be currently influenced by the falling dollar and trade negotiations.  Historically the falling dollar is best for mid-caps, since a falling dollar may help mid-caps grow internationally as they are big yet nimble enough to take advantage of new opportunities overseas.  However, energy is particularly sensitive to the dollar drop since oil is priced in dollars.  Though all sizes of energy performed well with oil’s recent rise, mid- and small-cap energy returned more than double its large cap counterpart, which is not surprising with rising oil as larger companies hedge more against the price volatility.

Source: S&P Dow Jones Indices

The S&P SmallCap 600 and S&P MidCap 400 respective gains of 6.4% and 5.9% to start the year outpaced large caps gain of 3.6%, which is historically typical in early bull markets.  However, it may be too soon to tell whether the Fed has more influence on the stock market than other unresolved issues both domestically and abroad like trade tensions, Brexit and the partial government shutdown. Historically in a rebound, the financial sector and real estate sector performed best but this bounce is led by energy, consumer discretionary, industrials and materials, showing the move may be more focused on issues abroad – in addition to interest rate comments from the FedIf the dollar rises more, small-caps have done historically best from their high percentage of domestic revenues, but energy might be put under pressure with the rising dollar, especially in the less hedged mid-and small caps.

 

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

Watching For Recession

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David Blitzer

Managing Director and Chairman of the Index Committee

S&P Dow Jones Indices

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Recent anxiety about an imminent recession sparked discussion of inverted yield curves and falling long term interest rates, The slope of the yield curve – the difference between the yield on the five or 10 year treasury note and a short term instrument like three month T-bills – may signal a recession. The chart shows the slope of the yield curve and recession dates since April 1953. The slope moved below zero as each recession began.

The idea of using the yield curve to predict the economy has a long history. Other combinations of treasury notes and bills show the same patterns; the choice of five or ten year notes and three-month bills gives the longest data history. There is some theoretical backing: when consumers and investors fear a recession is coming, they are likely to move assets into intermediate and long-term bonds as a hedge against future economic difficulties. This asset re-allocation may raise bond prices, lower yields and dampen the stock market. (See “Forecasts of Economic Growth from the Bond and Stock Markets” by Campbell Harvey, Financial Analysts Journal, September-October 1989)

While the first chart suggests that the yield curve is a useful predictor, the next chart shows that the stock market gives less accurate predictions. The market moves associated with the recessions in 2000-2001 and 1990-1991 were largely after the recessions. The economy kept on rolling despite the 1987 market crash.

The financial markets are not the only thing driving the economy – changes in employment matters.  The last chart shows the weekly Initial Unemployment Claims series published by the Bureau of Labor Statistics. When economic activity begins to fade companies respond by cutting hiring and letting people go. Jobs-losers file for unemployment. A rule of thumb is an initial claims number above 400,000 is cause for concern while a figure under 300,000 signals an unusually strong economy.

With all these, what is the risk of a recession near term? Initial claims suggest there is little to worry about while the yield curve signals some caution.

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