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The Performance of Carbon-Efficient Portfolios in Asian Markets

A Noble Metal Idea

SPIVA® U.S. Mid-Year 2019 Highlights

Winning by Losing Less

Outperforming with Systematic Sector Bets Using the S&P 500 Sector Rotator Daily RC2 5% Index

The Performance of Carbon-Efficient Portfolios in Asian Markets

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Akash Jain

Associate Director, Global Research & Design

S&P BSE Indices

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In recent years, governments have become increasingly aware of the perils of greenhouse gases and have aimed to penalize the source of pollution while looking to incentivize low-carbon technologies. In addition, investors are now considering an organization’s future financial position to discount potential write-downs of assets and the effect on revenues, costs, cash flows, and capital expenditure associated with adhering to policy changes that factor in climate risks. The global market for environmental, social, and governance (ESG) exchange-traded funds (ETFs) alone is expected to expand from USD 25 billion to more than USD 400 billion within a decade.[1] In Japan, sustainable investments grew fourfold between 2016 and 2018.[2]

In our recently published research paper, Integrating Low Carbon and Factor Strategies in Asia, we studied the performance of carbon-efficient and carbon-inefficient portfolios with sector-neutral and unconstrained approaches in seven Asian markets—Australia, China, Hong Kong, India, Japan, South Korea, and Taiwan. In each market, we ranked all companies in the base universe by their carbon intensity scores. The tertile (one-third) of the base universe with the lowest and highest carbon intensity scores constituted the unconstrained carbon-efficient and carbon-inefficient portfolios, respectively. Similarly, in the sector-neutral approach, carbon-efficient and carbon-inefficient portfolios were composed of the tertile of stocks with the lowest and highest carbon intensity scores from each sector, respectively.[3] We analyzed the performance of equal-weighted (see Exhibit 1) and float-market-cap-weighted baskets (see Appendix E of the research paper).

In the paper, we concluded that carbon-efficient portfolios resulted in a significant reduction to weighted average carbon intensity scores without sacrificing returns across Asian markets over long time horizons. We also observed that the carbon-efficient portfolios outperformed their respective carbon-inefficient portfolios across the seven markets on absolute and risk-adjusted bases over the entire studied period (see Exhibit 1).

In the unconstrained approach, the carbon-efficient portfolios had much lower weighted average carbon intensity scores than their respective carbon-inefficient portfolios, with carbon intensity reductions between 95.6% and 99.5% across all markets. The highest return spreads and volatility reductions were seen in China, Australia, and Hong Kong.

With sector constraints in place, the weighted average carbon intensity score reductions between the carbon-efficient and carbon-inefficient portfolios ranged from 84.3% to 95.8% across markets. China, Japan, and Hong Kong recorded the highest excess return spreads and reductions in volatility.

Furthermore, compared with the base universe, the carbon-efficient portfolios tended to deliver positive information ratios, while the carbon-inefficient portfolios had negative information ratios in most markets in the unconstrained and sector-neutral approaches.

As expected, the differences in carbon intensity scores, the return spread, and volatility reduction between the carbon efficient and carbon-inefficient portfolios were much more pronounced in the unconstrained approach. The tracking error of unconstrained carbon-efficient portfolios was relatively higher (4.6%-8.0%). However, in the sector-neutral approach, the tracking error of the carbon-efficient portfolios tended to be much lower (3.0%-5.9%).

[1]   Thuard, Johan, Harvey Koh, Anand Agarwal, and Riya Garg, “Financing the Future of Asia: Innovations in Sustainable Finance,” April 2019.

[2]   Kodaira, Ryushiro and Matsumoto, Hiroko, “After fending off eco-warriors, Asia Inc find ‘ESG’ investors hard to ignore,” Nikkei Asian Review, June 12, 2019.

[3]  For a detailed methodology of the research, please refer to Integrating Low Carbon & Factor Strategies in Asia.

 

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

A Noble Metal Idea

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Jim Wiederhold

Associate Director, Commodities and Real Assets

S&P Dow Jones Indices

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S&P Dow Jones Indices, the world’s leading index provider, launched the S&P GSCI Gold Dynamic Roll 70/30 Futures/Equity Blend in November 2019. It is the first single-commodity-focused futures/equities blended index of its kind in the gold market. In the current environment where investors are looking to diversify, this product is designed to provide a reliable and publicly available benchmark for the gold industry. It offers a new and unique way to track what is currently a popular commodity investment theme. This index is designed to measure the performance of a gold-focused, multi-asset allocation with exposure to both futures and equities returns. Commodities and equities tend to perform well at different points in the business cycle; for example, commodities tend to perform well during late phases of the business cycle, a time when equity returns tend to disappoint.

Over the past 10 years, gold-producing equities underperformed gold futures by a significant margin. However, 2019 has been different; the S&P Commodity Producers Gold Index outperformed the futures-based S&P GSCI Gold Dynamic Roll YTD as of October 2019. By combining gold futures with gold equities, market participants can partake in potential gold upside regardless of the instrument (asset class) the market uses to get there. Gold equities offer investors an underlying beta to the broad equities market as well as specific gold-related returns. Gold equities could also benefit from corporate actions such as M&A activity, specific company developments, and dividends. With managed money net positioning in CME gold futures at 10-year seasonal highs, there may be potential for a catch-up trade in gold equities. While gold equities could offer additional return streams over and above the underlying change in gold prices, they could also add new risks to a portfolio ranging from individual company hedging activities to mine disruptions.

Allocating to gold equities and gold futures via the S&P GSCI Gold Dynamic Roll 70/30 Futures/Equity Blend could offer a less volatile way for investors to allocate risk to the gold market.

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

SPIVA® U.S. Mid-Year 2019 Highlights

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Berlinda Liu

Director, Global Research & Design

S&P Dow Jones Indices

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The SPIVA U.S. Mid-Year 2019 Scorecard was published recently. The report shows that the strong rally in the domestic equities market in the first half of 2019 did not necessarily translate into success for active managers.

Active managers’ performance relative to the benchmark indices showed significant discrepancies in different market segments. For the one-year period ending in June 2019, 71% of domestic equity funds underperformed the S&P Composite 1500®, slightly more than the SPIVA U.S. Year-End 2018 report’s 69%. The majority of large-cap funds lagged their benchmarks, while mid-cap and small-cap active funds performed relatively better.

The outsized success of the mid- and small-cap funds may be explained by the performance divergence of the benchmarks. For the 12-month period ending in June 2019, the S&P 500® was up 10.4% and the S&P MidCap 400® gained a modest 1.4%, while the S&P SmallCap 600® fell 4.9%. Active managers in the two smaller-cap categories may have sized up into larger-cap securities in order to boost returns.

Performance discrepancy was even more prominent for growth managers. While most domestic large-cap growth managers were unable to keep up with the performance of the S&P 500 Growth (up 12%), more than 80% of mid- and small-cap growth managers beat their benchmarks for the one-year period ending in June 2019. Exhibit 2 shows that these two categories underperformed relative to large-cap growth.

The majority of fixed income active funds underperformed their benchmarks over the studied period, with the exception of global income funds. Of particular note, all government long funds and loan participation funds underperformed their respective benchmarks over the one-year horizon. This was in stark contrast to results from the SPIVA U.S. Year-End 2018 scorecard , when just 17% of government long funds and 57% of loan participation funds underperformed.

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

Winning by Losing Less

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Fei Mei Chan

Director, Index Investment Strategy

S&P Dow Jones Indices

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Except for a couple of hiccups, the U.S. stock market has more or less hummed along in an upward trajectory for 2019. Through October, the S&P 500 is up 23%. What is surprising is that the S&P 500 Low Volatility Index® outperformed the benchmark by almost 3%, gaining 26% over the same period. This is uncharacteristic because the low volatility index is designed to attenuate the performance of the S&P 500. But looking at the path that the S&P 500 took to arrive at current levels helps us understand why Low Vol has done so well even in a year when its parent index gained strongly. The chart below compares the performance of the two indices. Performance for Low Vol is a smoother line. This is expected but we also see that by losing less when the S&P 500 experienced two major dips in May (S&P 500: -6.35%, S&P 500 Low Volatility Index: -0.93%) and August (S&P 500: -1.58%, S&P 500 Low Volatility Index: +2.43%), it took less effort for Low Vol to regain its footing when the market began to recover.

In its current rebalance, effective after market close November 15, 2019, more than half of the eight names that left the index came from the Financials sector, scaling back the weight in the sector by 5%. The slack was picked up by Communication Services and Real Estate.

The Latest Rebalance for the S&P 500 Low Volatility Index Scaled Back Financials Significantly

Looking at the trailing one-year volatility for S&P 500 sectors compared to three months ago, there is nothing to indicate that Financials as a group became a lot more volatile. The S&P 500 Low Volatility Index targets low volatility at the stock level and for the latest rebalance at least, there seems to be more going on idiosyncratically than at the sector level.

Volatility for S&P 500 Sectors Is Consistent With Levels from Three Months Ago

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

Outperforming with Systematic Sector Bets Using the S&P 500 Sector Rotator Daily RC2 5% Index

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Karina Tjin

Analyst, Strategy Indices

S&P Dow Jones Indices

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Given the current market conditions, the popularity of strategies that rotate between factors or sectors, providing agility in their allocations with the goal of capturing outperformance in changing economic regimes, has increased considerably. One of these strategies is the S&P 500® Sector Rotator Daily RC2 5% Index. The index rotates between the top three sectors that have the highest relative value and highest short-term momentum. The index also has a risk control overlay with a daily target volatility of 5%.

The sector rotation component of the S&P 500 Sector Rotator Daily RC2 5% Index is crucial to its performance. We can see that, historically, there has been a diverse representation of sectors in the index (see Exhibit 1). The sector allocation rebalances every six months to capture potential changes in the sectors relative to their peers or in the macroeconomic environment. For example, the S&P 500 Sector Rotator Daily RC2 5% Index is currently allocated to Materials, Industrials, and Real Estate—sectors that traditionally outperform in the early to late expansion phases of the business cycle.

With respect to risk control, the S&P 500 Sector Rotator Daily RC2 5% Index uses the S&P 500, the S&P 10-Year U.S. Treasury Note Futures Index, and cash to target a volatility of 5% and protect the index against significant drawdowns. Exhibit 2 shows that the S&P 500 Sector Rotator Daily RC2 5% Index had varying amounts of exposure to equities, bonds, and cash in the studied period from June 2006 to October 2019. From October 2018 to October 2019, the index was allocated to equities and bonds, with the average equity exposure at 37.9% and average bond exposure at 62.1%. This high bond exposure was due to higher volatility in the equities market, which pushed the risk control to move toward less-volatile assets. When both equity and bond volatilities are high, the index allocates to cash, which is what occurred during the recession from 2007 to 2009.

In Exhibit 3, we can see that the index outperformed comparable strategies in terms of annualized and risk-adjusted returns. The S&P 500 Sector Rotator Daily RC2 5% Index demonstrated superior performance in the short and long term relative to the strategies that use either cash only or the S&P U.S. Treasury Bond Current 5-Year Index in terms of risk control. Having the sector rotation component built into the index is significant considering that the S&P 500 Daily Risk Control 5% Index, which does not use sector rotation, underperformed the other indices in our analysis. When compared with indices that use both sector rotation and risk control, such as the S&P 500 Sector Rotator Daily RC2 5% (5Yr Treasury) Index or the S&P 500 Sector Rotator Daily Risk Control 5% Index, we could attribute the higher performance of the S&P 500 Sector Rotator Daily RC2 5% Index to its allocation to the 10-Year Treasury. This could be due to the yield curve volatility in the shorter end of the curve in March 2019 and May 2019 and potential fears of a recession hindering the performance of the 5-Year Treasury.

Overall, the S&P 500 Sector Rotator Daily RC2 5% Index is designed to successfully capture the performance of sectors that achieve higher returns in different phases of the economic cycle and the risk control overlay effectively manages the volatility of the index.

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