Indexology^® Blog

The S&P MARC 5% Excess Return (ER) Index started the year firing on all cylinders, with positive returns across all asset classes for the quarter—dimming memories of 2018, when all the underlying indices ended the year in red.

Its asset class diversification and weighting strategy helped the index to stay positive throughout the quarter, despite a slight dip early on in the equities market. For all asset classes, the main contributors to performance continued to be equities and fixed income, with gold ending the quarter relatively flat.

When comparing the component assets to the S&P MARC 5% (ER) Index to see what periods the components outperformed or underperformed the index, the story is similar. In the middle of the quarter, we saw gold pick up in performance, which, when combined with equities, helped to offset some of the lower relative performance on the fixed income portion.

Looking at the rolling 252-day performance, for the 61 days in the quarter, we can see that in January of this year, the 252-day return would have been negative. This was due to the strong performance of the index from December 2017 through January 2018, which drove the index levels higher until volatility entered the market in February 2018. The 252-day performance from February 2019 through the end of the quarter maintained a somewhat upbeat trend, with the overall quarter having 54% of the days positive.

Looking at the index allocations of the quarter, after the year-end volatility of 2018, the equity allocation of the index was exceptionally low, at just 12.4% to start 2019 when compared with the historical average of 22%. Despite this tempered start, the index ended the quarter at 20.8%, close to its historical average, and with an average over the quarter slightly above 16%.

Passive use of factor strategies began with growth and value style investing. S&P Dow Jones Indices now offers single- and multi-factor indices that provide exposure to growth, quality, value, momentum, size, yield, and low volatility factors.

Factors perform differently depending on market conditions, economic cycles, or investor sentiment. Timing factors can be difficult. Many market participants combine factors as a possible way to achieve portfolio diversification.

There are different ways to form multi-factor portfolios,[1] and in a relatively small market like the Mexican equity market, it can be challenging. To meet this challenge, we constructed the S&P/BMV IPC Quality, Value & Growth Index with a two-step process of constituent selection and weighting.[2] A bottom-up integration approach is used in order to increase overall exposure to the desired factors.[3]

The underlying universe is the S&P/BMV IPC, which is widely considered as the barometer of the Mexican equity market. Because this benchmark already incorporates liquidity measures, there’s no need for additional liquidity criteria when applying factor overlays.[4]

1. Step One – Constituent Selection: We calculate the quality, value, and growth z-scores for each of the eligible stocks in the universe. A security must have at least one fundamental z-score for each factor (quality, value, and growth) to be included in the index. A stock is ineligible if any of the factor scores are among the four lowest-ranked securities by factor.
2. Step Two – Weighting Mechanism: At each rebalancing date, all securities eligible for inclusion are weighted by their final multi-factor score weight, which is the simple average of the underlying quality, value, and growth scores.

The number of constituents in the S&P/BMV IPC Quality, Value & Growth Index varies. On average, it has had roughly 24 constituents from June 17, 2005,[5] to Dec. 21, 2018, while its benchmark, the S&P/BMV IPC, has had 35.

Due to the weighting mechanism, we find that the multi-factor index differs meaningfully from the underlying benchmark. The active share, calculated by taking the sum of the absolute value of the differences of the weight of the S&P/BMV IPC Quality, Value & Growth Index and the weight of each holding in the S&P/BMV IPC divided by two, was greater than 50% (see Exhibit 2).

Exhibit 3 compares the fundamental characteristics of the multi-factor strategy to the benchmark. On average, the multi-factor strategy had more desirable quality characteristics, with lower financial leverage and accruals ratios, as well as higher operating return on assets. It also had higher value characteristics than the benchmark.

Despite having fewer securities, multi-factor strategies are possible in Mexico. The requirement is that there are sufficient fundamental or valuation differences among the constituents.

[1]   Innes, Andrew, S&P Dow Jones Indices, “The Merits and Methods of Multi-Factor Investing,” 2018.

[2]   For further information, see the S&P/BMV IPC Quality, Value & Growth Index section in the S&P/BMV Indices Methodology.

[3]   Sanchez, Maria, S&P Dow Jones Indices, “Blending Factors in Mexico: The S&P/BMV Quality, Value and Growth Index,” 2019.

[4]   For further information, see the S&P/BMV IPC section in the S&P/BMV Indices Methodology.

[5]   The first value date of the S&P/BMV IPC Quality, Value & Growth Index is June 17, 2005. For more information, please see our website at https://spindices.com/indices/strategy/sp-bmv-ipc-quality-value-growth-index.

Tomorrow, Warren Buffett and 30,000 of his closest friends will gather in Omaha for Berkshire Hathaway’s annual meeting.  The loyalty of long-term Berkshire shareholders is the stuff of legend, as is the investment performance that produced it.  $100 invested in Berkshire stock at the end of 1968 would have grown to more than $850,000 by the end of 2018; a comparable investment in the S&P 500 would have grown to just under $11,000.

Berkshire’s wealth generation has been all the more remarkable for having occurred in an era when the majority of active portfolio managers underperformed unmanaged indices like the S&P 500.  Academics have naturally been interested in how such exceptional results arose, with some arguing that “Buffett’s Alpha” is actually “a reward for leveraging cheap, safe, high-quality stocks.”

Regardless of the source of Berkshire’s excess returns, it’s unquestionable that their magnitude has been on a downtrend.  There are 40 (overlapping) ten-year performance windows in our 50-year history.  In the first 20 of them, Berkshire beat the S&P 500 by more than 10% per year.  In the second 20, Berkshire’s margin of outperformance hit double digits only 3 times; the last such period ended in 2002.

In fact, Berkshire’s compound annual return lagged that of the S&P 500 in the 10 years ended 2018 – in which respect it resembles most active large-cap U.S. equity managers, more than 85% of whom underperformed in the last decade.  Warren Buffett was recently asked whether Berkshire or the S&P 500 would be the better investment for a long-term investor and did not hesitate to answer that “I think the financial result would be very close to the same.”

When the premier active investment manager in modern financial history says that, you know that active management is a very hard game – and getting harder.

The commodities bull market party continued in April. The S&P GSCI was up 2.8% for the month and up 18.2% YTD. The Dow Jones Commodity Index (DJCI) was flat in April and up 7.6% YTD, reflecting its lower energy weighting. Petroleum prices, once again, were the standout drivers in the broad commodity index in April, as they have been all year. Agriculture and industrial metal prices dragged on overall performance for the month.

Oil prices continued to surge in April following the decision by the U.S administration to ban all Iranian oil purchases after May 1, 2019, ending sanction exemptions that had been in place for eight nations since last November. The S&P GSCI Petroleum ended the month up 7.0% and up 35.9% YTD. The intensity of supply disruptions in the global oil market, ranging from voluntary output cuts by OPEC and its allies to U.S. sanctions on Iran and Venezuela, have to date overwhelmed any concerns regarding sluggish global economic growth and the expectation of further increases in U.S. oil production. Undoubtedly, investor confidence and risk appetite also contributed to Brent crude oil pushing above USD 75 per barrel during the month for the first time since the end of October last year.

The S&P GSCI Industrial Metals gave back a significant proportion of its first quarter gains during April, leaving it up 4.8% YTD. Aluminum remained the laggard among industrial metals, with underperformance driven by expectations that additional aluminum smelting supply will come on stream over the remainder of the year. The S&P GSCI Aluminum fell 6.5% in April. Nickel prices also declined for the month, with the S&P GSCI Nickel down 6% but still up 14.2% YTD. Despite all the electric vehicle excitement in the nickel market, physical demand remains dominated by the Chinese stainless steel sector. Chinese stainless steel production was strong in the first quarter of the year but is forecast to tail off into the second half of 2019, as thin profit margins prompt producers to scale back.

The yellow metal has now given back almost all of its 2019 gains; the S&P GSCI Gold ended April up only 0.1% YTD. A supportive backdrop for risky assets has certainly curtailed investor interest in so-called safe haven assets. The level of attraction of gold for investors over the remainder of 2019 will likely depend heavily on the arc of U.S. interest rate policy and the strength of the U.S. dollar.

Malaise in the agricultural markets persisted in April. The S&P GSCI Kansas Wheat was the worst-performing constituent in the S&P GSCI YTD, down 21.1%. Higher planted area and favorable growing conditions across the major winter wheat production regions in Russia, Europe, and the U.S. suggests that supply will continue to weigh on the market. In the soybean market, there is growing concern that measureable progress on the U.S.-China trade war front has waned and the outbreak of African swine flu (ASF) in China will greatly reduce demand for U.S. soybeans, albeit temporarily. The S&P GSCI Soybeans was down 4.6% in April and 6.6% YTD.

Across the livestock complex, it was a relatively quiet month, with the S&P GSCI Livestock ending the month down 2.6% while holding onto a small yearly gain (1.2%). In contrast to the impressive recovery in hog prices in March, April proved more sedate, with the S&P GSCI Lean Hogs down 0.2% for the month. Hog market participants are torn between the demand opportunities for U.S. pork presented by the outbreak of ASF in China and the ongoing market access restrictions for U.S. pork in key export markets, as well as the risk of ASF spreading beyond China.

Since the 2008/2009 financial crisis, BBB-rated bonds have seen significant growth in the U.S. Today, they constitute more than half of the U.S. investment-grade bond market. The increasing share of BBB-rated bonds has dragged the S&P U.S. Investment Grade Corporate Bond Index average credit rating lower, and is accompanied with higher leverage of BBB-rated bond issuers.

The U.S. corporate bond market has grown significantly since 1980. Issuance paused briefly in 2008 and the growth continued shortly after the global financial crisis. From 2007 to 2018, U.S. investment-grade and high-yield corporate bond markets[1] grew by 194% and 98%, respectively.

During the same time period, growth of BBB-rated bonds (which have the lowest credit rating among investment-grade bonds), outpaced both investment-grade bonds as a whole and high-yield bonds. BBB-rated bonds increased by 330%, or from USD 0.8 trillion to USD 3.4 trillion at year-end 2018 (see Exhibit 1). As of Dec. 31, 2018, BBB-rated bonds made up 55% of the S&P U.S. Investment Grade Corporate Bond Index, compared with 37% in 2007 (see Exhibit 2).

The investment-grade index’s larger share of BBB-rated bonds pulled down its average rating about one notch, as shown in Exhibit 3, from its pre-crisis rating of above A- to currently between A- and BBB+.[2] Most of the rating deterioration happened between August 2011 and June 2012, possibly reflecting the knock-on effects of the of U.S. credit rating downgrade of August 2011, particularly on insurance borrowers. The downward trend of the investment-grade index average rating has continued since late 2012, though at a milder rate.

The credit fundamentals of investment-grade bonds have evolved since 2007. Leverage for BBB-rated bonds as a whole has risen, as measured by net debt/EBITDA and debt/enterprise value (EV). We calculated net debt/EBITDA and debt/ EV for U.S.-domiciled nonfinancial corporate issuers (ultimate parent) of bonds of sizes greater than USD 750 million and maturity of less than 10 years. Our analysis included public companies only.[3]

Since 2007, the net debt/EBITDA ratio for U.S. issuers of investment-grade bonds went up from 1.49x to 2.16x at the end of 2018, while net debt/EBITDA for issuers of BBB-rated bonds rose faster, to an elevated 3.08x. Exhibit 5 illustrates the same up-trend in debt/EV for both investment-grade bond issuers as a whole and for BBB-rated bond issuers in particular.

[1]   The S&P U.S. Investment Grade Corporate Bond Index and S&P U.S. High Yield Corporate Bond Index are used for this blog to approximate the U.S. investment-grade and high-yield corporate bond markets, respectively.

[2]   An equal-paced mapping is applied to convert letter-graded ratings to numerical scales and aggregate ratings on index levels.

[3]   For this analysis, we excluded bonds issued by the GE family because the combination of its volatile credit rating and high leverage ratio makes the index average leverage difficult to read.