Indexology^® Blog

The exchanged-traded fund (ETF) structure has led to increased investment options within fixed income, and the African markets are a clear example of this. Over the past few years, several African ETFs have been introduced to the market, tracking indices provided by S&P Dow Jones Indices in South Africa, Nigeria, and Namibia, giving investors options to participate in this investment space. With transparent indices and tight-knit local ties, S&P Dow Jones Indices and ETF providers have opened asset classes that historically were only accessible to large and more sophisticated investors. Market segments such as high yield, emerging markets, and international markets, which were inaccessible just a few years ago, have become an investment opportunity for all market participants. In addition to accessibility, the yields of African sovereign bonds have tended to be higher than both investment-grade and high-yield corporate bonds in the U.S.

The ETF structure has been around since the early 1990s and has become a popular approach to investing for both equity and debt investments. ETFs are no longer considered a niche product and a growing number of organizations utilize this investment vehicle. The ETF structure has made it easier and cheaper to own and trade big groups of securities at once, on demand. Investors can diversify their exposure by buying entire baskets of securities without buying and selling the underlying individual securities. Because of these efficiencies and benefits, ETFs are being used by investors and traders around the globe.

The popularity of ETFs can be understood by the benefits provided across asset classes. ETFs provide transparency and efficiency as an exchange-traded product that is priced continuously intraday. This makes it easy for an investor to discover the value, gain diversification, and trade in a tactical way. The ETF structure also provides low transaction fees, leading to low management costs, and it can also present tax efficiencies. Recent volatile times have provided a test to ETFs not seen since the global financial crisis of 2008. Nevertheless, ETFs have held their own and have been observed to be an efficient price indicator in challenging markets.

Despite the current economic challenges related to COVID-19, opportunities exist for investment in Africa. Over the past five years, Africa has gone from being a challenge in terms of its financial potential to an enticing prospect for emerging market investors.

A World Economic Forum study mentioned that by 2030, African household consumption is expected to reach USD 2.5 trillion. The study goes on to state: “Nearly half of that $2.5 trillion will be spent in three countries: Nigeria (20%), Egypt (17%), and South Africa (11%). But there will also be lucrative opportunities in Algeria, Angola, Ethiopia, Ghana, Kenya, Morocco, Sudan, and Tunisia. Any one of these countries would be a good bet for companies seeking to enter new markets.”

The African market continues to strengthen its position in the world by developing its economy, manufacturing capabilities, infrastructure, and technology. Additional investments will be required to keep African countries continually growing and achieving future expectations, but the efficiencies of an ETF can assist in making such an investment possible.

Income-seeking investors have always had to compromise between the level of dividend payments and the safety of dividend payments.   The importance of this tradeoff has recently gone viral, as governmental actions in response to COVID-19 have suppressed global economic activity, causing many companies to suspend or reduce their dividend payments.

Launched in 2005, the S&P High Yield Dividend Aristocrats Index comprises S&P Composite 1500® members that have increased their dividends annually for at least 20 years.   The market has rewarded consistent dividend payers: Exhibit 1 shows that the High Yield Aristocrats have outperformed the S&P 1500 over the long term.

As of the beginning of 2020, the aggregate capitalization of the High Yield Aristocrats amounted to 18% of the S&P 1500 Composite.  For comparison’s sake, we identified a list of “High Payers”  — the 18% of the 1500 Composite with the highest dividend yields. Exhibit 2 compares the median values of these two portfolios on a number of fundamental metrics that measure the strength of companies making dividend payouts.

The High Yield Dividend Aristocrats appear stronger across the board. For example:

• Earnings were double last year’s dividend payouts for the Aristocrats, vs. only 1.2x dividends for the high payers. Cash on hand was also a higher multiple of last year’s dividends.
• The Aristocrats used buybacks to return cash to shareholders to a greater degree than the high payers did. Since buybacks are likely to be reduced before dividends are cut, their usage provides a larger cushion for the Aristocrats.
• The Aristocrats are larger (median capitalization $12 billion) and more profitable (median ROE 15.5%) than their higher-paying counterparts.

There obviously can be no guarantees in a pandemic; if a company’s business is affected badly enough, dividend reductions are always possible regardless of how strong the income statement and balance sheet appeared a year ago. What this analysis tells us, though, is that the dividends of companies with consistent dividend growth are better protected from headwinds.

Could higher dispersion in sectors and industries translate to outperformance? S&P DJI’s Anu Ganti explores how index data can be used to inform tactical sector rotation strategies in periods of high volatility.

Get the latest sector dashboard: https://spdji.com/indexology/sectors/us-sector-dashboard.

It is unnecessary to give an update on today’s economic situation since most already have a wealth of information over the repercussions of the COVID-19 pandemic. I will instead focus on another major concern: how have pension funds performed, and furthermore, are there similarities in how they have performed during other crises?

After the S&P/BMV IPC dropped 16.38% from its highest monthly return posted in the past 10 years, the S&P/BMV Sovereign MBONOS Bond Index fell 0.72% and the S&P/BMV Sovereign UDIBONOS Bond Index followed with a loss of 3.10%. In this environment, we would expect that pension funds would have their worst month, or even their worst quarter.

Using data provided by Consar (available since December 2015),[1] we can see that Afore assets dropped 3.35%, the second-worst month in the past five years, with October 2018 taking the lead with a loss of 3.89%, as shown in Exhibit 1.

The pension fund system recently changed investment philosophy, moving from a target risk to a target date structure. Since the changes are so recent, we feel it is still appropriate to use the S&P/BMV Mexico Target Risk Index Series as a proxy to analyze performance before and during the COVID-19 crisis since instead of 4 strategies, now 10 different strategies are available with the same rules.

Exhibit 2 illustrates that despite performance losses, the indices had a positive slope and low volatility.

In Exhibit 3, we can see that March 2020 is the fourth-worst month since December 2008 for the S&P/BMV Mexico Target Risk Aggressive Index and S&P/BMV Mexico Target Risk Growth Index, while the S&P/BMV Mexico Target Risk Conservative Index held up well and did not rank among the lowest five months historically, driven by high exposure to fixed income indices and their performance relative to local and foreign equity. February 2009 was the worst-performing month for all the indices, which, interestingly was followed by the top monthly performance for all indices in March 2009, at 6.86%, 5.39%, 4.14%, and 3.53% for the S&P/BMV Mexico Target Risk Aggressive Index, S&P/BMV Mexico Target Risk Growth Index, S&P/BMV Mexico Target Risk Moderate Index, and S&P/BMV Mexico Target Risk Conservative Index, respectively.

Looking at quarterly results, we can see that the first quarter of 2020 was the third-worst quarter for all indices except the S&P/BMV Mexico Target Risk Conservative Index, while Q2 2013 and Q4 2018 suffered greater losses.

Yearly results show that only the S&P/BMV Mexico Target Risk Aggressive Index recorded a loss in 2018 (we consider the 0.01% loss of the S&P/BMV Mexico Target Risk Growth Index flat), and in 2013 all other indices finished in the black.

Without minimizing the current COVID-19 crisis, there is a glimmer of hope. History shows that crisis months with heavy losses can be followed by positive months and, when using a disciplined approach of diversification and risk management, even result in a year ending on a positive note.

While the results of the S&P/BMV Mexico Target Risk Index Series may differ from those of any particular Afore, the indices were created taking into account the investment regime of Consar (read more here) and provide a benchmark we can use with our own Afore. In conclusion, do not be afraid of a month with losses and instead use a disciplined investment approach in line with your risk tolerance.

[1] http://www.consar.gob.mx/gobmx/Aplicativo/WebDashboard/WebDashboard.htm

In February 2020, S&P Dow Jones Indices (S&P DJI) and the Association of Mexican Insurance Companies (AMIS) conducted the second annual survey of insurance investment officers in Mexico about the state of the local insurance industry. While this survey was meant to help take the pulse of the Mexican insurance market, what we did not predict was that shortly after the survey concluded, the Mexican economy would feel the combined shocks of COVID-19 and lower global oil prices.

We recently published the results of this survey to highlight the perspectives of the insurance investment officers at a point in time, with the recognition that this survey assumes relatively “normal” market conditions, and importantly, these are now no longer “normal” market conditions. With that in mind, we want to highlight some of the changes that have already taken place during the past month.

Downgrades and Negative Ratings Outlooks

On March 26, 2020, S&P Global Ratings lowered its local and foreign currency ratings on Mexico to ‘BBB+’ from ‘A-’ and to ‘BBB’ from ‘BBB+’, respectively. In line with this downgrade, on March 27, 2020, S&P Global Ratings also lowered its ratings on several Mexican insurance entities whose investment portfolios had a significant portion of sovereign debt (the details of which are outlined in this report).

In our survey, we asked respondents to focus on the asset allocation of their excess capital, where they have a bit more latitude in what they can invest. Between the 2019 and 2020 surveys, companies decreased their allocation to sovereign bonds while they increased their allocation to corporate, private, and foreign debt; still, sovereign bonds comprised the majority of their allocation of excess capital (see Exhibit 1).

At the time of the survey, more than 20% of respondents said they expected to decrease allocations to Mexican sovereign bonds. Given the current market conditions and ratings outlook, it is likely that this percentage would be much higher today.

A Liquid but More Volatile Mexican Peso

As my colleague María Sánchez noted in her recent blog post, the Mexican peso was the Latin American currency most affected in March 2020, with a depreciation rate of 16% relative to the U.S. dollar. Still, the peso remains a highly liquid currency.

The insurers we surveyed had relatively low expectations for cash as an asset class in 2020 even before the market crisis. We asked them to order several asset classes in terms of expected return—irrespective of their allocations or risk tolerances—where “1” corresponded to the highest expected return. Exhibit 2 shows the average ranking of the asset classes based on highest expected return in 2020; respondents expected cash to have the worst performance.

Separately, 17% of respondents said they expected to decrease their allocations to cash. Again, it is likely that this percentage would be higher given today’s market conditions.

Join us for a webinar on May 6 where representatives from S&P DJI and S&P Global Ratings will discuss the impact of COVID-19 and how insurers can get ahead of the headwinds facing the local insurance market. A replay of the webinar will also be available at the same link.*

*The webinar will be in Spanish.