Indexology^® Blog

An opportunity is knocking at the door of companies in Latin America. S&P Global published the Corporate Sustainability Assessment (CSA) Latin America Progress Report 2019, which revealed that, on average, Latin American companies only have one female director on their board of directors.

Reviewing the 125 constituents of the S&P Latin America LargeMidCap as of Dec. 31, 2019, we obtained similar findings.

A recent study, When Women Lead, Firms Win, conducted by Daniel J. Sandberg, showed that firms with a high level of gender diversity on their board of directors have been more profitable than companies with a low level of gender diversity.

This result supports the inclusion of gender diversity as a relevant and important metric in CSA, an annual evaluation of companies’ sustainability practices in different dimensions. Gender diversity is evaluated through the Corporate Governance and Labor Practice Indicators outlined in the CSA.

S&P Dow Jones Indices uses S&P Global’s information to generate the S&P DJI ESG Scores, which focus on the most financially material and relevant ESG signals within specific industries. With these scores, S&P Dow Jones Indices designed the S&P ESG Index Series. This global series of indices provides improved ESG representation while offering a overall industry group weights similar to that of the respective benchmark.

One of the potential benefits of ESG indices is to have greater exposure to companies with above-average female representation on their board of directors. We found that the S&P Latin America Emerging LargeMidCap ESG Index has 18.7% more exposure to companies with at least 15% female representation on their boards, as compared with the S&P Latin America LargeMidCap (see Exhibit 2).

When it comes to the proportion of women holding management positions, the figures are even more striking. Only 5.5% of companies in the S&P Latin America LargeMidCap have more than 50% of management positions held by women. For the S&P Latin America Emerging LargeMidCap ESG Index, this number is 7.8%.

Out of 129[1] Latin American companies assessed through the CSA 2019 that reported their composition, 10.9% companies had more than 50% of women in management positions.

While the S&P Latin America Emerging LargeMidCap ESG Index shows increasing exposure to companies with female representation on their board of directors, the Latin American region has room to improve diversity further and, in doing so, potentially improve profitability.

[1]   53.52% of 241 companies assessed in the CSA 2019.

Low volatility strategies have achieved considerable market acceptance in the aftermath of the 2008 financial crisis.  For most of the 12 years since then, skeptics have argued that low vol might become, and sometimes that it has become, overvalued.  It’s an understandable concern, especially in light of the continuing popularity of low volatility strategies.

We recently updated our 2016 study of The Valuation of Low Volatility to see what, if any, impact valuations might have on the future performance of the S&P 500 Low Volatility Index^®.  Our most important conclusion now, as it was then, is that valuations have little relevance as a leading indicator of Low Vol performance.

The chart below summarizes this point in one picture. It maps the monthly valuation of Low Vol (relative to the S&P 500) against its relative performance in the subsequent month. If it looks scattered, that’s because it is; the correlation between this month’s valuation and next month’s performance is 0.03.  As an indicator of entry and exit points for low volatility strategies, value does not appear to be valuable.

Scatter Plot of Monthly Relative Value Scores and S&P 500 Low Volatility Index Performance Spread in Subsequent Month Depicts No Relationship

For those wondering what role fixed income would have in their portfolio at record-low yields, they had to wait just one week. On Friday, Feb. 21, 2020, we hit a record-low yield for the 30-year Treasury, as the S&P U.S. Treasury Bond Current 30-Year Index yield fell to 1.92%. The next week, the Dow Jones Industrial Average proceeded to shed over 3,500 points and Treasuries maintained their safe haven status. Following an emergency 50 bps rate cut by the Fed, the 10-year set an all-time low, falling below 1% for the first time. The double digit returns in bonds YTD continue to buffer losses in investors’ portfolios.

The continual downward march in yields has created large shifts in the fixed income market structure, affecting investors who benchmark their portfolios to indices. Borrowers, for the most part, have taken advantage of lower rates to issue debt at lower levels, which lowers the potential return for investors. The coupon rates for fixed income indices have fallen 1%-2% over the past decade (see Exhibit 2). Ten years ago, investment-grade issuers were paying an average coupon of around 6%, while that is closer to what high-yield issuers pay today. While coupons have fallen, the interest rate risk has risen, as measured by modified duration. Borrowers have issued longer dated debt, increasing the index average by nearly 30% and 40% for investment grade and Treasury indices, respectively (see Exhibit 3). While interest rate risk has gone up, credit risk, as measured by the average credit rating of investment-grade issuers, has also increased (see Exhibit 4). BBB-rated securities account for 54% of the investment-grade market, up from 21% in 2000.

Futures markets seem to point to higher potential volatility in 2020 as we near the November 2020 general election. VIX^® futures price a premium leading into the November 2020 election and current delegate counts show a stark contrast in political policy to challenge the incumbent. With stocks coming off record highs and markets pricing for increased volatility around Election Day, there still appears to be a place for bonds in your portfolio.

Market participants today are living in a stressful environment, which includes rising interest rate risk, credit risk, and volatility risk. The potential diversification benefit of bonds in a portfolio context should be considered.

The S&P GSCI, a widely recognized measure of broad commodities market beta, fell 8.4% in February. The global spread of coronavirus represents a simultaneous demand and supply shock, a situation that is close to unprecedented in global commodities markets. Across these markets, losses in February were driven by the petroleum complex and livestock, while even precious metals was not accretive to headline performance.

The S&P GSCI Petroleum was down 12.5% in February. The spread of coronavirus had a measurable impact on demand for petroleum products, and particularly so in China, where factories and transportation infrastructure in the worst-affected regions have been shut down for weeks. Oil prices tend to reflect current physical supply and demand conditions, which means that they are often the first to respond to slowdowns in global economic activity, particularly if they are caused by a demand shock. The International Energy Agency (IEA) cut its 2020 global oil demand estimates in mid-February. The IEA is now forecasting a 435,000 barrel per day drop in global oil demand year over year for Q1 2020; this would be the first quarterly drop in demand in more than 10 years. On the supply side, OPEC+ has yet to react to the virus-related slump in demand by making additional production cuts. After only two months, the S&P GSCI Brent Crude Oil was down 24% year to date.

Gold remains one of the only bright spots in the commodities complex, but even it came under some pressure at the end of February, with the S&P GSCI Gold falling 1.2% in February. Gold’s popularity among investors has risen over the past 12 months in response to heightened global geopolitical tensions and falling global interest rates. This popularity was buoyed even further by the spread of coronavirus, which has added a new layer of uncertainty and complexity to global financial markets. Gold can benefit during periods of financial ambiguity and when investors’ appetite for risk is tempered, because it is viewed as an excellent store of value and in many cases can be held outside of the traditional financial market ecosystem.

Relative to other commodities, the S&P GSCI Industrial Metals exhibited a muted decline of 1.2% for the month. Looking beneath the surface, there was more disparity. Most metals declined, but the S&P GSCI Zinc was down the most, declining 8.4% and catching up with the underperformance seen in January from the rest of the base metals. Zinc inventory levels hit a 20+ year low at the London Metal Exchange on Feb. 4, 2020, but supply then shot higher by over 50% a few days later, helping to exacerbate the move lower in price. On a positive note and after a double-digit down month in January, the S&P GSCI Copper showed some signs of life, up 1.4% in February.

The S&P GSCI Agriculture fell 2.9% in February. Losses were spread evenly across the grains and softs markets, with only coffee bucking the trend. The S&P GSCI Coffee ended the month up 6.4%, enjoying somewhat of a bounce that was driven by tighter supplies of washed, quality coffee and speculators starting to liquidate short positions.

Live cattle prices plunged in February, leaving the S&P GSCI Livestock down 6.1% for the month. The potential spread of coronavirus in the U.S. has especially negative implications for beef demand given that beef is the most important meat protein in the foodservice sector and is also the most expensive animal protein source.

What story is Optimal Asset Management’s Factor Allocator’s analysis trying to tell us?  First, it is important to note each strategy has a factor fit quality reading above 80% (the S&P 500 High Dividend Index – 83.72% and the S&P 500 Dividend Aristocrats – 87.62%) which means the analysis of factor exposures appears useful in the explanation of the variation in returns of each strategy.  So, considering the historical performance of each of the factors explained above as well as how they each tend to behave during different market regimes, the S&P 500 High Dividend Index’s larger exposure to Value and Low Momentum coupled with its lack of Quality exposure may lead you to believe that S&P 500 High Dividend Index would have offered more volatility and lower returns when compared to the S&P 500 Dividend Aristocrats.

What about performance?  How has the historical performance of these two indices reflected their underlying factor exposures?  The table below is the performance since January 1995 for each strategy compared to the S&P 500 as of November 29, 2019 according to the Factor Allocator tool.

Interestingly both strategies performed well versus the S&P 500 with excess returns.  However, as suspected the S&P 500 High Dividend Index provided this return by experiencing more volatility.  Alternatively, the S&P 500 Dividend Aristocrats provided higher returns while providing a lower volatility experience.

So, while the Factor Allocator indicates each dividend index had a healthy exposure to the Low Volatility factor that would lead you to believe there would be some similarity in returns between the two, it was their differences that told the rest of the story.

What lesson can we learn from this analysis?  Factors can provide you a personality profile of the index portfolio to give you some indication of what you might expect.

The information contained herein has been provided by Andrew Neatt, Portfolio Manager and Investment Advisor with TD Wealth Private Investment Advice and is for information purposes only. The information has been drawn from sources believed to be reliable. Graphs and charts are used for illustrative purposes only and do not reflect future values or future performance of any investment. The information does not provide financial, legal, tax or investment advice. Particular investment, tax, or trading strategies should be evaluated relative to each individual’s objectives and risk tolerance.

Index returns are shown for comparative purposes only. Indexes are unmanaged and their returns do not include any sales charges or fees as such costs would lower performance. It is not possible to invest directly in an index.

TD Wealth Private Investment Advice is a division of TD Waterhouse Canada Inc., a subsidiary of The Toronto-Dominion Bank.

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