Indexology^® Blog

In the battle against the COVID-19 pandemic, the importance of healthcare has gained significance. Markets are witnessing new trends across asset classes, while meeting new challenges. Asset-allocation strategies are being reviewed to adjust to the new conditions. Equity sectors are facing the heat of these unprecedented times, but some trends are similar for both global and Indian markets.

The Health Care sector has been one such case. Not only has it outperformed over these past few months of uncertainty, but it also has had a good historical track record. Comparing the Health Care sectors of the Indian and U.S. markets, similar trends of outperformance versus their benchmarks were visible over different time periods. In the U.S. market, the Health Care Select Sector, which consists of all components of the S&P 500^® that are classified in the Health Care sector, had a 10-year annualized return of 14.63%, as compared with an 11.69% return from the S&P 500. In Indian markets, the S&P BSE Healthcare had a 10-year annualized return of 11.11%, as compared with a 6.74% return from the S&P BSE SENSEX (as of April 30, 2020). A study on the Australian market and its Health Care sector performance relative to its benchmark showed similar trends (read more here).

A comparison of the Health Care sector performance since January 2020 revealed that the majority of the sectors in the S&P BSE SENSEX, other than Health Care and Telecommunications, underperformed, including the S&P BSE SENSEX itself. The S&P BSE Finance, at -30.01%, and S&P BSE Industrials, at -27.27%, reflected the top sector laggards. The S&P BSE SENSEX, at -18.12%, was well below the S&P BSE Healthcare, which returned 14.32% for the period from Jan. 1, 2020, to April 30, 2020.

Taking an overview of this sector relative to other Indian benchmarks, such as the S&P BSE 100 and S&P BSE 500, further reflected the consistent outperformance of the S&P BSE Healthcare.

Of the 69 constituents in the S&P BSE Healthcare, the top 10 constituents were 65.53% of the total index weight as of April 30, 2020. Sun Pharmaceutical Industries Ltd and Dr. Reddy Laboratories, with index weights of 13.33% and 12.65%, respectively, constituted the top weights in the index.

How does the low volatility factor respond to periods of crisis and do the results tend to hold over the long term in India? S&P DJI’s Koel Ghosh takes a closer look at the low volatility anomaly in India.

Read more here: https://www.indexologyblog.com/2020/03/24/low-volatility-strategies-in-times-of-high-volatility/.

In 2019, the S&P 500® companies in aggregate paid a record $485 billion in dividends.  This year, the figure could be closer to $415 billion, and it could be another seven years before they recover to 2019 levels, according to futures prices.  Dividend futures, that is.

Index futures based on the level of the S&P 500 may be more familiar than those based on its dividends, but there is a simple connection between the two.  An arbitrage mechanism connects index futures prices to current (“spot”) values of the S&P 500; the difference between spot and futures prices depends on the difference between interest rates and dividend yields until expiry of the future.  Interest rates are knowable in advance; dividend payments are not.  Dividend futures are designed to hedge this uncertainty.

In 2015, the CME launched a futures contract based on the annual dividends paid by a portfolio tracking the S&P 500.  Today one can trade any of 11 contracts stretching out to the year 2030, with pricing based on “index points”; in 2019, for example, S&P 500 dividends amounted to 52.2 index points (versus an average S&P 500 index level of 2,913).   Each year’s contract is settled at the total dividend points paid during that calendar year.

Stock prices usually move faster than fundamentals, and dividend futures are typically more stable than stock index futures.  Not this year, however: the peak-to-trough decline in the 2020 S&P 500 dividend future in 2020 was 37%, compared to only 34% for the S&P 500.  Having fallen further, the dividend future then lagged the recovery afterwards.  The S&P 500 closed yesterday around the same level it began last October; the 2020 dividend future is still 15% lower.

The collapse in 2020 dividend expectations is more extreme considering that some dividends have already been paid this year: in the first quarter, aggregate S&P 500 dividends were still breaking payout records.  Looking at the next contract out, the 2021 futures contract is currently priced at 44 – another 12% below this year’s future – and is perhaps a better guide as to what dividend run rate to expect in the medium term. 

The existence of dividend futures ranging out several years allow us to make comparisons with total dividends paid historically and anticipated in coming years.  To put the information expressed by futures prices in a tangible context, using the same mathematics that converts an index level to the aggregate capitalization of all the index constituents, we can express the prices of dividend futures in terms of the total dollar amounts of dividends paid out by the companies in the S&P 500.  Exhibit 2 illustrates the conversion from annual futures prices into total aggregate dividends, in comparison to historical payments to shareholders.

Of course, futures prices are not perfect predictions. The dividend futures markets may be overly pessimistic – they have tended to underestimate payouts historically.  But there are plenty of reasons to suppose that prices should recover faster than dividends.  Declining U.S. Treasury yields offer a justification for valuations to increase faster than fundamentals (as discount rates fall), while dividends themselves may prove less popular with some shareholders and CEOs during a time of economic uncertainty.  Time will tell, but if we take futures prices as imperfect guides, it seems fair to conclude that S&P 500 dividend payments could slow considerably in the short term and take quite a few years more to recover.

On April 20, 2020, the S&P Eurozone LargeMidCap Paris-Aligned Climate Index (S&P Eurozone PA Climate Index) was launched (see press release). This index has been designed to align with recommendations from the Task Force on Climate-related Financial Disclosures and follow the new minimum standards for EU Paris-Aligned Benchmarks proposed by the EU,[1] while remaining as close as possible to its benchmark index, the S&P Eurozone LargeMidCap.

The current market conditions have put the effectiveness of the index methodology to the test. One of the main requirements of the regulation is that the carbon intensity of the index adheres to a strict trajectory of 7% reduction year-on-year.

In this short piece, we will analyze the impact of the recent market movements on the carbon intensity of the S&P Eurozone PA Climate Index and whether this has impeded the index’s ability to meet its 7% decarbonization goal.

First, we need to ask ourselves: why does market movement affect the index’s carbon intensity?

There are several approaches to measure the “carbon intensity” of a portfolio. The EU regulation stipulates that the carbon intensity of a company should be measured by dividing its Greenhouse Gas (GHG) emissions by its Enterprise Value Including Cash (EVIC). The index carbon intensity is the weighted-average carbon intensity (WACI) of its constituents. Therefore, when the EVIC of the index portfolio increases, the index WACI decreases and vice versa. Since the market capitalization of equities contributes substantially to EVIC, it is reasonable to assume that when the index level goes down, the carbon intensity of the index goes up.

In the first quarter of 2020, the S&P Eurozone LargeMidCap’s WACI (including Scope 3 emissions) increased by 18%. However, the chart shows that the main driver of this change was the 14% decrease in the average EVIC of its constituents (see Exhibit 1). Put simply, the recent market drop has made the carbon intensity of the index appear worse even without any companies necessarily increasing their GHG emissions.

The question remains: has the S&P Eurozone PA Climate Index remained below its decarbonization trajectory during this period? The answer is a resounding yes (see Exhibit 2).

The yellow line indicates the 7% decarbonization trajectory required for the S&P Eurozone PA Climate Index. The index has remained below its allocated trajectory for every quarter since its inception. We can see that in the two periods (December 2018 and March 2020) when the EVIC suffered substantial decreases (see Exhibit 1) the S&P Eurozone PA Climate Index’s WACI moved closer to its required trajectory, but never exceeded it.

The dependency of EVIC on WACI was already noted by the Technical Expert Group (TEG) recommendations. To ensure that GHG emissions change is the main driver of the decarbonization of any climate benchmark, the TEG proposed adjusting the WACI by the average index-level EVIC increase/decrease (see Exhibit 3).

Exhibit 3 shows that the S&P Eurozone PA Climate Index’s adjusted-WACI tracks the required trajectory closely. This is because the WACI adjustment for index-level EVIC changes is an integral part of the methodology (see page 12 of the methodology).

In short, since the S&P Eurozone PA Climate Index targets decarbonization using the adjusted-WACI approach, we can rest assured that significant changes in the benchmark index level will have little impact on it meeting its climate objectives.

Exhibit 3 also shows that S&P Eurozone LargeMidCap-adjusted WACI has only reduced 3.4% since December 2016, while the S&P Eurozone PA Climate Index has reduced its WACI by 25.7%, well below the 21.0% required by the trajectory for the same period, without overshooting the required trajectory.

In summary, the current market conditions have provided an excellent opportunity to test the robustness of the methodology behind the S&P Paris-Aligned Climate Indices. The S&P Eurozone PA Climate Index passed with flying colors and successfully maintained its climate objectives. Now, back to business as usual.

Dividend-paying companies have been in the spotlight as a direct consequence of the ongoing COVID-19 pandemic and crude oil glut crisis. A combination of strained corporate cash flows and political intervention has seen many companies cancel, cut or postpone payments globally.

In this blog, we examine the potential impact of these events on the S&P DJI Dividend Indices.

The Dividend Review Timetable

Broadly, there are two categories of reviews: monthly and annual/semiannual. Monthly reviews are intended for maintenance, typically to remove stocks that have cancelled their dividends, while annual or semiannual rebalances are full reviews of each index to ensure alignment with their respective methodologies. The schedule of reviews (see Exhibit 1) gives us a timeline of potential constituent changes for various dividend indices. Per the timeline, the most imminent change is the April monthly review (effective as of April 30, 2020, close).

April 2020 Monthly Review: 36 Securities Deleted across 12 Indices

The S&P DJI Index Committee confirmed the deletions from its dividend indices as part of its regular monthly reviews on April 23, 2020. However, it also announced that it will suspend the April and May 2020 monthly reviews for the S&P UK High Yield Dividend Aristocrats (HYDA) and the S&P Euro HYDA.

Exhibit 2 highlights all changes from the review; the S&P Global Dividend Aristocrats, S&P/TSX Canadian Dividend Aristocrats, and S&P 500® High Dividend Index will have the most changes in terms of number of securities and index weight.

Most Indices May See Limited Medium-Term Impact

Based on public announcements, we further analyzed the existing index constituents to evaluate potential turnover at the upcoming annual reviews or subsequent monthly reviews. To accomplish this, we assigned constituents into four main categories (see Exhibit 3):

• Announced Drops: As confirmed by the S&P DJI Index Committee;
• Cancel/Decrease: Companies that have publicly indicated or been advised to cancel or decrease dividends;
• Increase/Maintain: Companies that have announced they would maintain or increase dividends;[1] and
• Unknown: Companies that have not announced or postponed ex-dates.

With the exception of the S&P UK HYDA and S&P Euro HYDA, a large part of the S&P Dividend Aristocrats Indices could have a limited impact, with an average of 6% indicating a cancel or decrease, while 84% announced they would maintain or increase.

Looking across all dividend indices, we identified five indices that see greater than 20% of their respective compositions under the Cancel/Decrease category: the S&P UK HYDA, S&P Euro HYDA, S&P Emerging Markets Dividend Opportunities Index, Dow Jones EPAC Select Dividend Index, and Dow Jones Asia/Pacific Select Dividend 30 Index. The S&P UK HYDA stands out and is reflective of the dividend landscape in the UK, where over 40% of companies have cancelled dividends.

It is important to note that the Unknown category does not necessarily indicate negative action. Companies in this category have simply not made announcements or postponed their ex-dates.

Sectors Impacted Varied across Regions

The sectoral impact for indices with greater than 10% of their index compositions categorized under Cancel/Decrease and Announced Drops was relatively distinct for each region. The impact in Asia Pacific was largely concentrated among three sectors, in contrast to other regions that were more distributed. Exhibit 4 shows that Materials contributed meaningfully to all regions and Retailing also had a significant impact for most regions, particularly Asia Pacific.

These are unprecedented and testing times for dividend strategies, and the S&P DJI Index Committee continues to monitor and take necessary action to ensure its dividend indices conform to their objectives. While many of the S&P U.S. Dividend Indices have weathered the storm relatively well, the standout was the S&P 500 Dividend Aristocrats, which had no deletions announced for the April monthly review. Interestingly, it also incorporates the deepest sustainable screen by only including companies that have increased dividends over 25 years.

This blog does not provide any indication of the likely course of action by the S&P DJI Index Committee, with the exception of the confirmed and announced changes.

[1]   For the S&P High Yield Dividend Aristocrats and S&P MidCap 400® Dividend Aristocrats, only increases were considered in Increase/Maintain, while maintained dividends were classified under Cancel/Decrease.