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Unlikely Tariff Rollback Deflated Commodities in November

Stock Pickers: Hope Springs Eternal

Integrating Low-Carbon with Single Factors in Asia

Should Green Benchmarks Include Fossil Fuel Stocks?

The Performance of Carbon-Efficient Portfolios in Asian Markets

Unlikely Tariff Rollback Deflated Commodities in November

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Fiona Boal

Head of Commodities and Real Assets

S&P Dow Jones Indices

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The broad commodities were tepid in November. The S&P GSCI was flat for the month and up 9.9% YTD. The Dow Jones Commodity Index (DJCI) was down 2.1% in November and up 4.5% YTD. Gains were driven by the energy complex, while both precious metals and industrial metals detracted from headline performance.

The S&P GSCI Petroleum was up 2.0% in November. Oil prices were poised to end the month near two-month highs on expectations of an extension of OPEC+ production cuts, but on the last trading day of the month prices fell by over 4% due to fresh concerns over U.S.-China trade talks and a record high U.S. crude output of 12.5mm barrels per day. OPEC and Russia are likely to extend existing production cuts by another three months to mid-2020 when they meet in early December. In the physical oil market, traders are paying near-record premiums for sweeter crude barrels, as new marine fuel regulations from the start of 2020 have encouraged refiners to use crude oil grades that produce less high-sulphur fuel oil.

The S&P GSCI Nickel was in freefall in November, down 18.1%, with the largest move by far within the industrial metals space. This was due to the market focusing attention on current subpar demand, even with Indonesia cutting back exports. Prices for stainless steel, of which nickel is a component, have continued to decline due to record inventories. With a technical drop in support of its 200-day moving average and market participants’ bullish positions exited, the environment was ripe for a big move lower. In spite of these conditions, the S&P GSCI Nickel was still up 29.5% YTD and was one of the better-performing commodities overall. The S&P GSCI Lead and the S&P GSCI Zinc fell about 10% and 8% respectively, while the S&P GSCI Iron Ore rose 7.71% after falling 5.9% the prior month.

The S&P GSCI Gold lost some of its luster in November, down 3.1% on the back of an overall better risk sentiment, with equity markets continuing to post new all-time highs and VIX® near multi-month lows. However, gold’s loss was palladium’s gain. The S&P GSCI Palladium continued to add to its impressive YTD performance, reaching another new high on the last day of the month to close November up 3.4% and up 55.55% YTD.

The S&P GSCI Agriculture was down marginally in November. As harvest in the U.S. comes to an end, both the corn and soybean markets have continued to be weighed down by the protracted U.S.-China trade talks and plentiful domestic supplies. Improving weather for planting in Brazil and Argentina also added pressure to the markets. The S&P GSCI Coffee ended the month up 13.4%; Arabica coffee supplies have  tightened from recent record levels, with a global deficit now forecast for the 2019-2020 season, an off-year for top producer Brazil’s biennial crop cycle. Certified stocks on the Intercontinental Exchange (ICE) also fell to their lowest level in nearly 18 months.

It was another mixed bag for the livestock sector in November; the S&P GSCI Lean Hogs was down 11.0%, while the S&P GSCI Live Cattle rose 2.8%. Despite the fact that the U.S. sold more pork this year to international buyers than ever before, the S&P GSCI Lean Hogs was down 22.9% YTD, reflecting a significant increase in pork supply. U.S. pork production is on a record pace for 2019.

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

Stock Pickers: Hope Springs Eternal

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Anu Ganti

Senior Director, Index Investment Strategy

S&P Dow Jones Indices

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The Wall Street Journal recently quoted several active managers who claim that “conditions for stock picking are improving”. Their rationale is that declining correlations among stocks in the S&P 500 have made it easier for active managers to select stocks based on fundamental analysis.

We have heard this argument before, most notably in 2014 when, as Exhibit 1 demonstrates, correlations had fallen substantially from their financial crisis peak. But 2014 was also a year of record underperformance by active managers, as our SPIVA scorecards demonstrate. As we have argued previously, this is because dispersion, not correlation is the appropriate metric with which to measure the prospective success of stock pickers.

Correlation is a vital tool in analyzing portfolio diversification, but it is dispersion, or cross-sectional portfolio volatility, that offers a more meaningful way to identify opportunities for active management.  Exhibit 2 offers a simple illustration that demonstrates this point:

Compare stock pairs A and B versus C and D. Both pairs have an average return of 6.85%, but it’s obvious that an active manager who can choose between C and D can add more value than her competitor who chooses between A and B. And yet – the correlation of A and B is negative, while the correlation of C and D is 1.0. Dispersion, not correlation, determines the value added potential of active managers.

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

Integrating Low-Carbon with Single Factors in Asia

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Akash Jain

Associate Director, Global Research & Design

S&P BSE Indices

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Factor investing in Asia has grown at a rapid pace, with smart beta passive AUM growing at a 42% compound annual growth rate over the past five years, albeit from a relatively lower base.[1] With increasing awareness of climate change and related risks, investors may look to integrate carbon screening into their factor portfolios.

In our research paper, Integrating Low-Carbon and Factor Strategies in Asia, we constructed pure factor portfolios (momentum, value, quality, and low volatility) and studied the impact of carbon screening on these portfolios in seven Asian markets—Australia, China, Hong Kong, India, Japan, South Korea, and Taiwan. The pure factor portfolios were constructed by selecting the top quintile of stocks by factor scores from each market from their respective base universe. The carbon-efficient factor portfolios included the same number of stocks as in their respective pure factor portfolios, but were selected from the carbon-screened universe, from which the 33% of stocks with the highest carbon intensity scores were removed. The pure factor and carbon-efficient portfolios were unconstrained by sectors and were equally weighted. The carbon-efficient screening affected the performance and carbon intensity of each factor portfolio differently (see Exhibit 1).

Overall, the carbon screening resulted in higher carbon intensity reductions to the low volatility and value factors than to the quality and momentum factors across Asian markets. Carbon-efficient screening also improved risk-adjusted returns for the quality, value, and momentum portfolios. In contrast, low volatility factor performance was adversely affected by the carbon-efficient screening.

Additionally, carbon screening resulted in different sector exposures when compared with the pure factor portfolios. For example, compared with the pure quality portfolios, the carbon-screened quality portfolios tended to overweight Financials and Information Technology and underweight Materials and Consumer Staples (except in Australia). On the other hand, compared with the pure value portfolios, the carbon-screened value portfolios tended to overweight Financials and Consumer Discretionary and underweight Materials and Energy. For the momentum and low volatility factors, carbon-efficient factor portfolios tended to overweight Financials and Consumer Discretionary and underweight Materials with respect to pure factor portfolios.

Exhibit 2 shows the active factor exposures (in terms of the number of standard deviations) of the carbon-efficient factor portfolios versus their respective pure factor portfolios in Japan. In most cases, the impact of carbon-efficient screening was modest on the targeted factor exposures. Similar observations were made in other Asian markets. We can conclude from these results that carbon-efficient screening did not result in the loss of targeted active factor exposure.

[1]   Banerjee, Alka, “ETFs and the Factor-Based Investing Landscape,” Forum Views: One World One BBF, Vol. 8, Issue 1, pp. 154-156, April 2019.

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

Should Green Benchmarks Include Fossil Fuel Stocks?

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Mona Naqvi

Senior Director, Head of ESG Product Strategy, North America

S&P Dow Jones Indices

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As green investing becomes ever more mainstream, there is greater scrutiny of the myriad “environmentally friendly” investment products that have emerged. Several green-labeled benchmarks have been criticized for including oil and gas stocks, for instance, sparking some controversy within the sustainable investment community. However, while efforts to make financial products more transparent are laudable, not all arguments favoring divestment depict a complete and accurate picture. More often than not, divestment is more principled than practical when it comes to achieving the low-carbon transition.

As an independent index provider, S&P Dow Jones Indices has the responsibility of being transparent with its methodologies and marketing. Educating stakeholders, including investors, policymakers, and the media, is key to bridging expectations with the financial jargon that often plagues lengthy methodology documents. This is especially relevant in climate finance, for which the threat of “greenwashing” looms large. But divesting from fossil fuels is just one approach—and not all “green” products necessarily ought to do so. Indeed, the climate-conscious investor has two options.

  1. Divest: To align one’s investments with one’s values and send a reputation-hitting signal that potentially reduces a firm or industry’s license to operate.
  1. Engage: To retain a seat at the table to influence company behavior, drive industry change, or advance a particular cause.

The divestment movement does not argue that divesting will necessarily decrease a company’s value—it is primarily an expression of values for the principled investor. Engagement, on the other hand, is a tool for effecting a particular change. That said, more than 1,000 institutional investors with USD 11 trillion in assets are divesting from fossil fuels,[1] with some citing motives such as the avoidance of stranded-asset risk. Many banks and insurers have also committed to neither finance nor underwrite fossil fuel projects, inevitably slowing the industry’s expansion. However, divestment will not likely move a company’s stock price so long as there continue to be many investors who do not share the same moral virtues.[2] Ultimately, both approaches are valid, depending on the objectives of the individual investor.

This dichotomy is well understood in the active space, given shareholder advocacy, but there are parallels with passive investing too. If engagement is any strategy that influences company behavior, then benchmarks can also be an effective tool for engagement. Take the S&P Carbon Efficient Index Series, for instance (see Exhibit 1).

By excluding any of the world’s 100 biggest carbon emitters who don’t disclose, and retaining reweighted exposure to all other companies—including fossil fuel stocks—the S&P Carbon Efficient Index Series reduces the carbon footprint by as much as 20%-45%, while uniquely encouraging:

  1. Greater transparency, by rewarding companies that disclose emissions with a 10% higher index weight; and critically,
  1. The transition of business models toward low-carbon alternatives over the long term, as companies seek to improve their standing in the index.

Our novel methodology sorts companies into deciles by carbon intensity within GICS® industry groups and reweights them accordingly. However, since some industries are inherently more greenhouse gas-emitting than others, we consider the spread of industry group emissions and adjust weights by a greater or lesser extent, depending on how much a company can feasibly improve given available technologies (see Exhibit 2).[3] Companies are thereby incentivized to disclose and decarbonize to boost their overall standing. So although fossil fuel-free strategies tick certain boxes, they typically achieve less in terms of decarbonizing prowess.

Thus, so long as a methodology is transparent with its aims, it may make sense to include fossil fuel stocks in green indices. Naysayers may want to look closer at whether a strategy intends to divest or engage, because while both are green, only one is actually “greening.”

[1]   Source: https://www.ft.com/content/4dec2ce0-d0fc-11e9-99a4-b5ded7a7fe3f

[2]   See https://www.newyorker.com/business/currency/does-divestment-work for an explanation for why divestment requires a critical mass of adopters to have any real impact on stock prices.

[3]   Click here to learn more about the S&P Carbon Efficient Index Series and Industry Group Impact Factor Weights.

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

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.