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Happy Birthday to the Communication Services Sector

S&P High Yield Dividend Aristocrats Part III: Sector Composition, Performance Attribution, and Factor Exposure

Have Passive AUMs Eclipsed Active?

Saudi Oil Attacks - A Text Book Supply Shock

2018 Institutional SPIVA®: A Couple of Takeaways

Happy Birthday to the Communication Services Sector

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Anu Ganti

Senior Director, Index Investment Strategy

S&P Dow Jones Indices

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The Communication Services sector turns one year old on Sept. 24, 2019. A year ago, the Global Industry Classification Standard® (GICS®) replaced the old Telecommunication Services sector with a new Communication Services sector, which combined telecom with some companies that had formerly been classified in the Information Technology and Consumer Discretionary sectors. As a result, Telecommunication Services, once the ugly duckling comprising three stodgy phone companies, metamorphosed into a sector that included high-growth companies such as Alphabet, Facebook, and Netflix. Over the past 12 months, the sector outperformed the S&P 500®, up 8.55% versus the market’s 4.22%.

After this change, the average constituent volatility of Communication Services has been higher than that of the old Telecommunication Services. Some investors might therefore assume that the volatility of the new index is also higher than that of its predecessor, but this is paradoxically not the case. We predicted last year that the volatility of the new sector would be roughly the same as the old, resulting from the juxtaposition of two opposing forces: Communication Services’ higher dispersion, which drives volatility higher, is balanced by lower intra-sector correlations, which pull volatility lower.

A year later, our forecast has come to fruition. As seen in Exhibit 1, Communication Services’  average volatility (19.25%) is only slightly higher than that of Telecommunication Services (17.65%), and this increase came at a time when the S&P 500 overall was much more volatile. As predicted, Communication Services has higher average dispersion and much lower correlations than did Telecommunication Services.

Based on the data from Exhibit 1, we observe that the volatility of Telecommunication Services was 69% higher than that of the S&P 500 in the year prior to the GICS changes. Since then, the volatility of Communication Services has been only 23% higher than that of the market, implying that Communication Services is much more market-like than its predecessor. We can see this firsthand through the factor exposures in Exhibit 2. Telecommunication Services had a high exposure to dividend yield and value. In stark contrast, Communication Services tilts away from dividend yield and low volatility, as well as away from small size, and is relatively more exposed to momentum and high beta. As a result, the sector now behaves more like the market.

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

S&P High Yield Dividend Aristocrats Part III: Sector Composition, Performance Attribution, and Factor Exposure

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Bill Hao

Director, Global Research & Design

S&P Dow Jones Indices

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In this blog, the third in our introduction to the S&P High Yield Dividend Aristocrats®, we will cover sector composition, performance attribution, and factor exposure.

Sector Composition

As shown in Exhibit 1, the S&P High Yield Dividend Aristocrats has diversified sector exposures, with some sector bets, given different dividend-paying practices among sectors. Historically, the S&P High Yield Dividend Aristocrats has had higher exposure to the Financials, Utilities, Consumer Staples, Industrials, and Materials sectors, in terms of absolute weight and weights relative to the S&P Composite 1500®. In contrast, the index has had much lower exposures to the Energy, Information Technology, and Health Care sectors.

Performance Attribution

We analyze the sources of the historical excess returns of the S&P High Yield Dividend Aristocrats versus the S&P Composite 1500. Grouping by sectors, we look at the sector allocation[1] and individual stock selection effects (see Exhibit 2).

Performance attribution shows that individual stock selection contributed to 75% of monthly active returns, while sector allocation contributed to 25%. Thus, the outperformance of the S&P High Yield Dividend Aristocrats mainly came from stock selection rather than sector allocation.

Factor Exposures

We used the Fama-French Five-Factor Model[2] to dissect the historical returns of the S&P High Yield Dividend Aristocrats (see Exhibit 3). From the factor loading estimates and associated t-statistics, we can see that the S&P High Yield Dividend Aristocrats constituents had positive exposures to lower beta, better value, higher operating profitability, and more conservative investment growth. Profitability and investment growth are considered to be quality factors.

The empirical results show that the constituents had better valuation and quality characteristics than the overall market. From business operations and financial perspectives, high quality fundamentals form the foundation for consistent dividend increase.

From our three-blog installment, we can conclude that the S&P High Yield Dividend Aristocrats has consistently had higher yields than its benchmark. Further, performance attribution and factor exposure analyses showed that the strategy’s outperformance was mainly due to stock selection and that its constituents have had good value and quality characteristics. In return, such solid fundamentals have driven its long-term favorable risk-adjusted returns and defensive characteristics.

For more information, see the two previous blogs in the installment.

[1]   The sector allocation effect is the portion of portfolio excess return attributed to taking on sector bets in comparison with the benchmark. Individual stock selection effect is the portion of portfolio excess return attributable to individual stock selection when the sector weight is the same as that of the benchmark.

[2]   Fama, E. and K. French. “Dissecting Anomalies with a Five-Factor Model.” The Review of Financial Studies, Volume 29, Issue 1, 2016, pp. 69-103.

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

Have Passive AUMs Eclipsed Active?

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Craig Lazzara

Managing Director and Global Head of Index Investment Strategy

S&P Dow Jones Indices

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“You all did see that on the Lupercal
I thrice presented him a kingly crown,
Which he did thrice refuse.”

Julius Caesar, Act 3

This morning’s Wall Street Journal declared that “Index Funds Are the New Kings of Wall Street.”  The coronation, and similar notes of the “end of an era,” were prompted by Morningstar data showing that, for the first time, the assets invested in index-tracking mutual funds and ETFs exceed the AUM of actively-managed funds which aim to outperform.  As index providers, we’re gratified to see the extent of investor acceptance of our services, but, like Caesar, we renounce the crown.

In any event, it’s important to understand the extent of our putative domain.  The Morningstar data are based on mutual fund and ETF assets under management.  This is a popular data set because it’s easy to access – funds are legally required to report their AUM.  Pensions, endowments, individuals, etc. have no such requirement, at least not on a continuous basis.  As the WSJ article notes, indexed mutual funds, though 50% of mutual fund and ETF assets, account for only 14% of the value of the entire U.S. equity market.

This estimate is consistent with our own research, which suggests that indexing amounts to between 20% and 25% of the U.S. equity market.  Even this lower figure is remarkable given that index funds did not exist 50 years ago; the growth of indexing surely counts as one of the most significant developments of contemporary financial history.

Indexing started because active management overpromised and underdelivered, as our SPIVA reports have consistently demonstrated.  The challenges to active management in the last 50 years are arguably a product of its success in the decades prior.  Active investing is intrinsically a zero-sum game; the only source of outperformance for one investor is the underperformance of another.  As they came to dominate global markets, it became impossible for professional investors as a group to deliver above-index performance.

As indexing has grown, the benefits to investors – in terms of underperformance avoided and fees saved – have been substantial.  The bars in the chart above show the growth of assets tracking the S&P 500, S&P MidCap 400, and S&P SmallCap 600.  As of December 2018, those assets totaled nearly $3.9 trillion.  The green line represents our estimate of the cumulative savings in management fees over the past 23 years; the savings cumulate to $287 billion.

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

Saudi Oil Attacks - A Text Book Supply Shock

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Fiona Boal

Head of Commodities and Real Assets

S&P Dow Jones Indices

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The attacks on Sept. 14, 2019, on Saudi Arabia’s oil facilities have put the oil market back in focus for investors and policy makers alike. The event was reported to have been the largest single supply disruption in the oil market for half a century, crippling half of Saudi oil production and temporarily halting production of 5.7 million bpd or approximately 5% of global oil production. This is a textbook example of a supply shock in a commodity market.

It remains to be seen exactly how long it will take this oil production to come completely back online and what the attack may mean in terms of further instability in the region, as well as the escalation of geopolitical risks in the global oil market.  But from an investor’s perspective, there are two interesting observations to highlight regarding the price response in the immediate aftermath of the supply shock.

  1. The price response on the first trading day following the attack was extreme but could also be viewed as an aberration. The S&P GSCI Brent Crude Oil closed 14.2% higher on Sept. 16, 2019, the biggest one-day percentage gain since at least 1989, while the energy-heavy S&P GSCI was up 7.9%. Exhibit 1 offers a visual representation of the size and rarity of this one-day price move in the S&P GSCI Brent Crude Oil.
  2. Not all energy assets are created equal when it comes to their immediate responsiveness to a supply shock. Exhibit 2 illustrates the range of price moves across a variety of S&P DJI energy indices on Sept. 16, 2019. As expected, the supply shock caused by the Saudi attacks had a relatively muted impact on the major equity and fixed income energy indices. The speed and extent to which a physical oil supply shock flows through the balance sheets of companies in the energy sector can vary greatly depending on hedging activity, balance sheet structure, geographic location, financial health, position in the supply chain, asset mix, level of supply chain integration, government regulation and historical beta to the broader equity and debt markets among others.

It remains to be seen what long-term impact, if any, the Saudi attacks will have on oil prices and the value of energy companies’ equity and debt. At one end of the spectrum, the 1990 oil price shock, in response to the Iraqi invasion of Kuwait, saw the S&P GSCI Crude Oil increase 140% between the end of July 1990 and mid-October 1990. On the other hand, there have been numerous short-lived supply-related spikes in oil prices – admittedly not of the size that was witnessed on Sept. 16, 2019 – that were quickly reversed and locked safely in the annals of history.

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

2018 Institutional SPIVA®: A Couple of Takeaways

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Hamish Preston

Associate Director, U.S. Equity Indices

S&P Dow Jones Indices

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S&P Indices Versus Active (SPIVA) scorecards provide mainstay performance comparisons between active managers and benchmarks.  Our latest Institutional SPIVA scorecard shows once again how difficult active managers found it to beat benchmarks, net- or gross-of-fees.  Here are a couple of highlights.

2018 proved challenging for institutional equity managers, although institutional fixed income managers showed some strength.

The fourth quarter of 2018 witnessed a complete turnaround in sentiment, as uncertainty over Fed policy and renewed trade tensions between the U.S. and China contributed to a rise in volatility.  Although such conditions are commonly believed to favor active managers, the data suggests otherwise: in most categories, a majority of institutional equity funds underperformed their benchmarks last year, even gross-of-fees.

However, institutional active fixed income managers navigated the turbulence more surefootedly: a majority of managers beat their benchmarks, before fees, in 11 out of the 17 fixed income categories in 2018.

 

Incorporating a profitability screen in small cap benchmarks would have made them harder to beat.

We have written quite recently about the potential benefits of incorporating a profitability screen in small caps and S&P Dow Jones Indices launched the S&P Global SmallCap Select Index Series earlier this year in order to allow benchmark comparisons.  Exhibit 2 shows the impact on the SPIVA statistics when switching our international small cap benchmark to one of these small cap select indices – the S&P Developed Ex-U.S. SmallCap Select Index.

Over every timeframe, more funds beat the S&P Developed Ex-U.S. SmallCap Index (which does not require small cap companies to have a track record of positive earnings) than the corresponding small cap select index (which does).  And over the 5- and 10-year periods ending December 2018, such a switch in benchmarks would convert the international small cap category from one in which a majority of institutional active funds outperformed, to a one in which a majority underperformed.

To find out more about the latest results and for more information on the active versus passive debate, visit out SPIVA microsite.

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