Investment Themes

Sign up to receive Indexology® Blog email updates

In This List

The S&P Eurozone Paris-Aligned Climate Index Concept Sensitivity Analysis: Decarbonization over Time

Women and the S&P Latin America Emerging LargeMidCap ESG Index

The Irrelevance of Value in Low Volatility

Fixed Income in Stressful Times

Coronavirus Hits Commodities Markets in February

The S&P Eurozone Paris-Aligned Climate Index Concept Sensitivity Analysis: Decarbonization over Time

Contributor Image
Ben Leale-Green

Analyst, Research & Design, ESG Indices

S&P Dow Jones Indices

two

To meet the proposals for CTBs or PABs,[1]—as published by the EU Technical Expert Group (TEG) in its Final Report,[2] —active share[3] and therefore tracking error are uncertain over time,[4] due to the TEG’s absolute decarbonization proposal.[5] This blog assesses the S&P Eurozone Paris-Aligned Climate Index Concept’s (PAC Concept) potential active share sensitivity to future decarbonization, to align with a 1.5 °C scenario.[6] Exhibit 1 shows future PAB and CTB trajectories and possible parent index trajectories from 7% decarbonization and 3% carbonization. If in twenty years the parent index carbonizes at 3% year-on-year, a 90% relative carbon reduction will be required for the PAB (hopefully far higher than will be observed).

In January, S&P Dow Jones Indices released a paper for the PAC Concept—designed not only to meet the TEG’s proposals for PABs but incorporate transition risk, physical risk, and climate opportunities, as recommended by the TCFD7 (see Exhibit 2).

Baskets have been calculated using the methodology outlined,[8] with 50%-90%[9] decarbonization constraints. The aim is understanding how potential future relative carbon reductions, due to 7% year-on-year decarbonization, will affect diversification and active share of the PAC Concept.[10] The PAC Concept active share sensitivity analysis has been calculated with all other constraints held constant.[11]

Exhibit 3 shows the stock count and effective number of stocks[12] at each level of decarbonization. As decarbonization increases, the number of stocks decrease—this decrease in stock count is gradual until 90% decarbonization, which would be an extreme level of decarbonization. Furthermore, as stock count decreases, the effective number of stocks decreases at a slower rate—meaning the PAC Concept methodology allows concentration to increase at a slower rate than stock count decreases. Even at 90% decarbonization, which is very high, there is still reasonable diversification within the PAC Concept.

Exhibit 4 shows the sensitivity of active share as decarbonization increases. We can see a similar story as in Exhibit 3, where decarbonization up until 70% has a small impact on active share, and only when 90% decarbonization is targeted does active share jump.

Why is there a non-linear relationship between decarbonization and active share/effective number of stocks/stock count? Exhibit 5 shows the carbon intensity distribution for companies in the S&P Eurozone LargeMidCap, which have a heavy positive skew. This skew means decarbonization until a certain point does not require much active share. As decarbonization requirements increase, it takes more active share to meet the decarbonization constraint. When more significant weight can be taken out of high-emitting companies, this causes a large impact on the PAC Concept’s carbon footprint. However, as carbon reduction requirements grow, there is little or no weight to be taken from these highest-emitting companies, so weight must be taken from less carbon-intensive companies. This weight reduction in less carbon-intensive companies has a lower impact on the carbon footprint.

Overall, the PAC Concept appears to be able to decarbonize by an amount that is in line with a worst likely scenario, without causing drastically poorer diversification.

1 Regulation (EU) 2019/2089 has created two new categories of benchmark; Regulation (EU) 2019/2089 has created two new categories of benchmark; and the EU Climate-Transition Benchmark.

2 The EU Technical Expert Group on Sustainable Finance Final Report on Climate Benchmarks and Benchmarks’ ESG Disclosure, September 2019.

3 Active share measures how much of the parent index would have to be sold to invest in the PAC concept. ; where w is the weight of stock i.

4 Leale-Green, B. (2019, November). The EU Climate Transition and Paris-Aligned Benchmarks: A New Paradigm. Retrieved from Indexology Blog: https://www.indexologyblog.com/2019/11/07/the-euclimate-transition-and-paris-aligned-benchmarks-a-new-paradigm/

5 The final report published by the TEG proposes that CTBs and PABs decarbonize at 7% year-on-year, regardless of the parent index’s decarbonization. This means at any point in time, the relative carbon intensity reduction from the parent index is uncertain.

6 IPCC, 2018: Global warming of 1.5°C. An IPCC Special Report on the impacts of global warming of 1.5°C above pre-industrial levels and related global greenhouse gas emissions pathways, in the context of strengthening the global response to the threat of climate change, sustainable development, and efforts to eradicate poverty [V. Masson-Delmotte, P. Zhai, H. O. Pörtner, D. Roberts, J. Skea, P.R. Shukla, A. Pirani, W. Moufouma-Okia, C. Péan, R. Pidcock, S. Connors, J. B. R. Matthews, Y. Chen, X. Zhou, M. I. Gomis, E. Lonnoy, T. Maycock, M. Tignor, T. Waterfield (eds.)]. In Press.

7 TCFD. (2017). Final Report: Recommendations of the Taskforce on Climate Related Financial Disclosures.

8 Leale-Green, B., & Cabrer, L. (2020). Conceptualizing a Paris-Aligned Climate Index for the Eurozone. S&P Dow Jones Indices. Retrieved from https://spindices.com/documents/research/research-conceptualizing-a-paris-aligned-climate-index-for-the-eurozone.pdf

9 Analysis was performed on the S&P Eurozone LargeMidCap universe for a hypothetical rebalance in November 2019.

10 All other data has been held constant; in the future, other datasets in the PAC Concept will change, as will the parent index constituents and weights. Therefore, more or less active share may be required to hit the same levels of decarbonization in the future.

11 The constraints aim to meet the proposal for PABs and introduce transition risk, physical risk, and climate opportunities, as laid out by the TCFD.

12 The effective number of stocks (EN) is a measure of index concentration.  EN is calculated as: ; where w is the weight of stock i. The lower the value for EN, the more concentrated the index. The value for EN will fall between 1 and the number of stocks in the index (if the stocks are equally weighted).

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

Women and the S&P Latin America Emerging LargeMidCap ESG Index

Contributor Image
Maria Sanchez

Associate Director, Global Research & Design

S&P Dow Jones Indices

two

An opportunity is knocking at the door of companies in Latin America. SAM, part of S&P Global[1] and a global leader in ESG data, published the SAM Corporate Sustainability Assessment 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 SAM’s Corporate Sustainability Assessment (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 SAM’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 risk/return profile 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[2] 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]   S&P Global to Acquire the ESG Ratings Business from RobecoSAM.

[2]   53.52% of 241 companies assessed in the CSA 2019.

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

The Irrelevance of Value in Low Volatility

Contributor Image
Fei Mei Chan

Director, Index Investment Strategy

S&P Dow Jones Indices

two

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

 

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

Fixed Income in Stressful Times

Contributor Image
Brian Luke

Global Head of Fixed Income Indices

S&P Dow Jones Indices

two

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

Coronavirus Hits Commodities Markets in February

Contributor Image
Fiona Boal

Head of Commodities and Real Assets

S&P Dow Jones Indices

two

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.

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