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Commodities Performance Highlights – March 2019

Using the S&P/JPX Dividend Aristocrats® to Invest in Japanese Dividend Growers

S&P 500® Has Best First Quarter in over 20 Years – But Upward Momentum Slows

Using GARP Strategies for Indices Part II – Constituent Selection

Financial Advisers’ View on the Australian ETF Market

Commodities Performance Highlights – March 2019

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Fiona Boal

Managing Director, Global Head of Equities

S&P Dow Jones Indices

It has been a noteworthy start to 2019 for commodities. The S&P GSCI was up 1.6% in March and up 15.0% YTD. The performance of the Dow Jones Commodity Index (DJCI) was more modest in March, up 0.1%, and it was up 7.5% YTD, reflecting its lower energy weighting. Petroleum prices were the standout driver of broad commodity index performance over the first three months of the year. In contrast, the agricultural commodities proved to be a drain on overall performance, and, while investor interest in precious metals remains well above previous years, price moves have been meek. The later part of the economic cycle is typically characterized by the outperformance of commodities, particularly industrial commodities (namely energy and industrial metals). This implies that the continued strength in commodities will be highly dependent on global economic activity data remaining strong, the U.S. Federal Reserve maintaining its dovish bent, and top commodity consumers such as China continuing to support commodity-laden activity.

Oil prices posted their strongest quarterly price gain in almost 10 years in Q1 2019. The S&P GSCI Petroleum ended the month up 2.9% and up 27.1% YTD. In mid-March, OPEC scrapped its planned April meeting, declaring that it would now delay any decision to extend production cuts until June, once the market had assessed the impact of U.S. sanctions on Iran and the crisis in Venezuela. However, it is clear that cracks in the OPEC Plus union are emerging. OPEC’s de facto leader Saudi Arabia favors cuts for the full year, while Russia, which joined the agreement reluctantly, is seen as less keen to restrict supply beyond September. While supply has been the main driver of the recent price appreciation, it is worth recalling that demand is what led to the sizable price decline in the final months of 2018. There are nascent signs that Asian demand has stabilized, but there are growing concerns regarding European demand.

Performance across the industrial metals complex was more disparate, leaving the S&P GSCI Industrial Metals flat for the month. The rise in commodities this year has been partly fueled by hopes for an agreement to end a trade war between the U.S. and China. Zinc and nickel were the standout beneficiaries of such growing expectations, and, combined with critically low inventory levels, this pushed the S&P GSCI Zinc and S&P GSCI Nickel up approximately 21% YTD. Aluminum is the laggard industrial metal YTD, and the S&P GSCI Aluminum was down 0.2% in March and up a relatively meek 3.4% YTD. Investor concerns regarding rising aluminum supplies have been heightened since the Russian aluminum giant Rusal resumed sales to the U.S. market, following its removal from the U.S. sanctions list.

A stronger U.S. dollar, growing expectations of a trade deal between the U.S. and China, and a general rise in investors’ risk appetite all contributed to gold posting its second consecutive down month in March (down 1.6% for the month and up only 0.9% YTD). These factors were more than sufficient to offset any support from the apparent end of interest rate increases in the U.S. Gold is traditionally seen as a safe place to invest during periods of uncertainty; higher interest rates hurt gold because they make bullion, which pays no yield, meaning it is less attractive to investors, while a stronger U.S. dollar can depress demand by making gold more expensive for buyers in other currencies.

As is often the case, the release of the USDA’s Prospective Plantings report on the last trading day of the first quarter accounted for the bulk of the excitement in the agricultural markets in March. The USDA pegged U.S. corn plantings 1.5 million acres higher than the market expected, and domestic corn inventory halfway through the 2018/2019 marketing year came in 270 million bushels heavier than predicted. The S&P GSCI Corn ended the month down 3.7%. The USDA placed March 1, 2019, soybean stocks at record levels, while soybean acres came in 1.55 million below the trade estimate, but the S&P GSCI Soybeans still ended the month down 2.7%. The only bright spot in the agricultural sector in March was cotton, with the S&P GSCI Cotton up 6.8% for the month and up 6.2% YTD, reflecting the USDA’s forecast for considerably lower cotton acres. Grain market participants will now turn their focus to the planting season and specifically the impact, if any, of recent flooding on planting progress and the final U.S. acreage mix.

The standout performer across the commodity complex in March was lean hogs, with the S&P GSCI Lean Hogs up 23.8% for the month and up 6.9% YTD, pushing the broader S&P GSCI Livestock up 5.5% in March and up 3.9% YTD. Lean hogs spent the first two months of the year in the doldrums fixated on higher-than-expected levels of U.S. pork production and ongoing market access restrictions for U.S. pork in key export markets. By March, these factors were dwarfed by the realization that the scope, severity, and impact of the African swine flu outbreak in China had potentially been greatly misunderstood.

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

Using the S&P/JPX Dividend Aristocrats® to Invest in Japanese Dividend Growers

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Izzy Wang

Senior Analyst, Factors and Dividends

S&P Dow Jones Indices

While some dividend-paying companies give out occasional and unsustainable dividends, dividend-growing companies—such as household names like Coca-Cola, Exxon Mobile, and AT&T in the U.S.—provide steadily increasing dividend payouts every year.

These long-standing dividend growers are called “Dividend Aristocrats,” and there are two reasons for it. First, with successful business operations and disciplined financial management, they are solid free-cash-flow generators and thus have a secured cash source to support their dividend policy for many years. Second, once a company promises increasing dividends, it has to live up to the market expectation.[1]

Japan’s economy features its own household names (known as Ote kigyo 大手企業, “big corporates,” or Yumei kigyo 有名企業, “famous corporates”). Many of them are the stars of the prosperous Keiretsu economy: names such as Sumitomo, Mitsui, and Mitsubishi. Others—such as energy suppliers and banks—started out regionally and expanded nationwide. Another younger group of big names gained a leading position with successful new business models and market popularity. For example, NTT DoCoMo, the predominant mobile operator, serves over 73 million customers in Japan and has a global presence in APAC, Europe, and America.

The S&P/JPX Dividend Aristocrats provides a transparent, rules-based way to track the Japanese Dividend Aristocrats,” a way to quantify the “Yumei kigyo.” This index includes Japanese companies that have increased and maintained dividends for at least 10 straight years. Its most recent constituents include popular brands such as Lawson Inc., Yahoo Japan, and NTT DoCoMo (see Exhibit 1). There are region-based companies: Osaka Gas, which serves 68 million households covering 3,220 square kilometers; Shizuoka Bank, which received the highest rating by Moody’s among all Japanese financial institutions; Okinawa Electric Power; and Fukuoka Financial Group. Keiretsu names are included as well: Mitsubishi UFJ Lease and Finance, Sumitomo Forestry Co, and Sony Financial Holdings.

Although the hurdle of dividend increases and maintenance for index inclusion is 10 years, most constituents have a longer history of paying out increasing dividends (see Exhibit 2). The four top-ranking companies (Topre Corp, Osaka Gas Co, Nippon Kayaku Co, and Takeda Pharmaceutical Co) have an impressive record of 33 straight years. The index average is 19 years and over 90% of constituents have paid increasing or stable dividends for more than 10 straight years.

To see the benefit of the Dividend Aristocrats investment, take Topre Corp. as an example of a typical scenario. If we invested JPY 10,000 into Topre Corp. 13 years ago, thanks to its increasing dividend policy (see Exhibit 3), we would have received a total of JPY 3,059 in dividends by the end of 2018, at a constant 2% return from the dividend income every year. This profit would be in addition to capital appreciation. By the end of 2018, our equity investment would more than double from JPY 10,000 to JPY 22,380 (see Exhibit 4), an impressive average annual price return of 4.4% despite the 2008 financial crisis and the 2018 meltdown in the Japanese market.

A broader picture with more constituent examples and with the S&P/JPX Dividend Aristocrats as a whole shows a similarly beneficial performance. Exhibit 5 shows the hypothetical returns for the top three constituents (by index weight) and for the index. As in the Topre Corp. example, we would invest JPY 10,000 for each stock or the index at the end of 2005 and hold it for 13 years. We saw excess returns for all cases when compared to the TOPIX during the period.

Exhibit 6 visualizes the performance of the S&P/JPX Dividend Aristocrats as measured by both total return (with dividends) and price return (without dividends) since index launch.

For investors who are worried about market volatility but wish to maintain equity exposure to generate income, the Dividend Aristocrats with their stable dividend growth may be attractive.

[1]   Refer to A Case for Dividend Growth Strategies.

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

S&P 500® Has Best First Quarter in over 20 Years – But Upward Momentum Slows

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Louis Bellucci

Senior Director, Index Governance

S&P Dow Jones Indices

The S&P 500 finished Q1 2019 up 13.07%. This was the best first quarter return since the 13.53% posted in Q1 1998. January’s 7.87% return was the best start to the year since 1987 (13.18%). The hot start cooled some with the 10th-best February since 1987, at 2.97%. In March, the upward momentum slowed further, posting a 1.79% return, making it the 15th-best March since 1987. Overall, 32 of the 42 segments of the U.S. equity market had lower consecutive returns from January to February and then February to March.

To begin the month, on March 1, the S&P 500 closed above 2,800 for the first time since Nov. 8, 2018. Throughout March, the S&P 500 challenged the 2,800 resistance level multiple times. It closed at 2,854.88 on March 21, which was the highest point since the index closed at 2,880.34 on Oct. 9, 2018. The S&P 500 hovered around 2,800 as the market awaited new developments in the U.S.-China trade talks and the Federal Reserve’s outlook dimmed. Fears of slowing growth also factored into decelerating the upward momentum.

As was the case in 2019, the S&P 500 posted positive returns during all three months of the first quarter on eight other occasions over the past 30 years, most recently at the start of 2013. April was also positive six of those eight times. In every year that the first three months were all positive, the S&P 500 not only ended the year positive, but also ended higher than the Q1 index level.

The S&P MidCap 400® (-0.74%) and S&P SmallCap 600® (-3.53%) were both negative for the month of March. Thirty-three of 42 segments of the U.S. equity market had lower returns in March than in February, but only 19 were negative. Nine of 11 large-cap sectors were positive, compared to 6 of 11 mid-cap and only 4 of 11 small-cap sectors. Information Technology was the best-performing large-cap sector, with a 4.75% return in March, but it was the seventh-best sector in both the mid- and small-cap segments. Financials was the worst-performing sector in all three size segments. Additionally, growth outperformed value for the third consecutive month.

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

Using GARP Strategies for Indices Part II – Constituent Selection

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Wenli Bill Hao

Director, Factors and Dividends Indices, Product Management and Development

S&P Dow Jones Indices

In a previous blog, we took the first and second steps in our Growth at a Reasonable Price (GARP) strategy construction. We introduced the GARP investment strategy and showed how it can be implemented systematically. In this blog, we will take the third and fourth steps: using a multi-factor sequential filtering process for security selection and establishing constituent weights.

Multi-Factor Sequential Filtering Process

There are a number of approaches one can take to construct multi-factor portfolios—mainly integration,[1] sequential filtering, and optimization. We use the sequential filtering method because it is easy to understand and effective in achieving its targeted factor exposures.

Multi-factor sequential filtering selects stocks using two layers of filters, as shown in Exhibit 1. In the first step (filter 1), stocks are ranked by their growth z-scores, with the top 150 stocks remaining eligible for constituent inclusion. In the second step (filter 2), those 150 stocks are then ranked by their quality & value (QV) composite z-scores. The top 75 stocks are selected to be included in the strategy after applying a 20% buffer rule.[2] The 20% buffer is applied to reduce portfolio turnover.

Constituent Weights

Once constituents are selected at each rebalance, eligible securities are weighted by their growth score[3] to achieve the strategy’s growth exposure. To limit the impact of extreme values, the maximum weight of a security is capped at 5%. Individual GICS® sector exposure is capped at 40% to broaden the strategy’s sector exposure.

In this and a previous blog, we discussed our GARP strategy construction process. In coming blogs, we will present the empirical results of the strategy performance, its sector composition, and its performance attribution.

[1]   S&P Quality, Value & Momentum Multi-Factor Indices Methodology, February 2019.

[2]   Buffer Rule: A 20% buffer is implemented as follows:

  1. Stocks in the top 150, based on growth z-score, are ranked by their QV composite z-score. The top 60 stocks are automatically chosen for index inclusion.
  2. Stocks that are current constituents that fall within the top 90 based on their QV composite z-score are chosen for index inclusion in order of their QV composite z-score.
  3. If at this point 75 stocks have not been selected, the remaining stocks are chosen based on their QV composite z-score until the target count is reached.

[3]   Please see Footnote 7 from the last blog for growth score computation.

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

Financial Advisers’ View on the Australian ETF Market

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Stuart Magrath

Former Senior Director, Channel Management, Australia and New Zealand

S&P Dow Jones Indices

At the recent Australian Indexing & ETF Masterclass series held in Melbourne & Sydney, we asked the audience, 83% of whom were Financial Advisers, a number of questions using a mobile-enabled polling tool. Over 260 people attended the Masterclass across the two cities, and 189 of these people used the polling tool. 767 discrete votes were received across the six polls that we conducted. The results provide a snapshot of Financial Adviser views on ETFs, current usage, planned future usage and the prime considerations in selecting ETFs. Let’s look at the results in detail.

Our first poll asked the audience to nominate a range that represented their usage of ETFs in client portfolios. The largest response was for the highest range.

  1. A full 29% of advisers indicated that between 76-100% of their client portfolios use ETFs;
  2. 12% of respondents indicated that their client portfolios use between 51-75% ETFs; and
  3. 24% of respondents polled said that between 26-50% of their client portfolios were ETF driven.

These results combined indicate that 65% of advisers are using ETFs for at least 25% of their client portfolios.

Our second poll question asked attendees the split between Australian-listed vs internationally-listed ETFs used in client portfolios. The splits reported were as follows:

  1. 16% of respondents only use Australian-listed ETFs;
  2. 16% of respondents mainly use Australian-listed ETFs;
  3. 46% of respondents split usage 50:50 between Australian-listed and internationally-listed ETFs;
  4. 18% of respondents mainly use internationally-listed ETFs;
  5. 4% of respondents only use internationally-listed ETFs.

Our third poll sought to ascertain the indexing and ETF topics in which attendees are most interested. The results came out as follows:

  1. 35% of poll responses nominated Equities & Sectors;
  2. 22% nominated Smart Beta/Factors;
  3. 15% nominated Fixed Income;
  4. 13% went for ESG; and
  5. 10% put their hands up for Commodities.

We also asked attendees, whether they expect their usage of ETFs to increase over the next 12 months:

  1. 76% indicated their use of ETFs will increase;
  2. 21% indicated there would be no change in use; and
  3. 3% indicated their use of ETFs will decrease.

When asked a follow up question, as to the expected increase in ETF use over the next 12 months respondents provided the following results:

  1. 12% expect to increase usage by 81-100%;
  2. 12% expect to increase usage by 61-80%;
  3. 20% expect to increase usage by 41-60%;
  4. 32% expect to increase usage by 21-40%;
  5. 22% expect to increase usage by 1-20%; and
  6. 2% expect no increase in their use of ETFs.

Our final poll questions to the Masterclass audience asked what their prime considerations are when selecting ETFs. The results were as follows:

  1. 32% look to the ETF issuer’s reputation in making a selection;
  2. 22% look at the liquidity of the ETF and 22% also consider the expense ratio;
  3. 13% consider past performance; and
  4. 10% consider the Index provider’s reputation.

These results, pleasingly, demonstrate that there is a propensity to increase the use of ETFs as tools within client portfolios to achieve investment objectives. While just over 1/3 of respondents nominated Equities and Sectors as their topic of greatest interest, it is also pleasing that other topics have a solid level of interest also, indicating, that while equities are the core of ETF use, other asset classes are also on advisers’ radar.

The responses also provide valuable insights into the topics that we can address at future adviser-facing events, including our 10th Annual Indexing and ETF Masterclass scheduled for Q1, 2020.

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