Indexology^® Blog

The SPIVA® Canada Year-End 2019 Scorecard was released recently. Despite the strong performance of broad equities, 2019 proved to be yet another challenging year for active funds in Canada. Here are a few highlights from the report.

Strong Market Performance Did Not Translate to Active Fund Outperformance

The S&P/TSX Composite posted its highest annual return (22.9%) since 2009, ending a decade-long bull run that saw a total gain of 94.9%. Amid this historic bull market, however, 92% of Canadian Equity funds underperformed their benchmark in 2019 and 86% underperformed over the past decade.

Similarly, smaller-cap names in the S&P/TSX Completion gained 26.1%, setting a high bar for active managers to surpass—84% of Canadian Small-/Mid-Cap Equity funds underperformed the benchmark. However, over the long term, this was the best-performing category relative to the benchmark—30% of managers outperformed in the past decade.

International Equity Funds Fared Better, but Not in the Long Term

Funds with a more international flavor did better in 2019 than their domestic counterparts. International Equity funds performed the best across all categories, with 57% underperforming the S&P EPAC LargeMidCap. Longer-term results continued to disappoint, however, as 85% of International Equity funds underperformed over the 10-year period.

Larger Funds Outperformed Smaller Funds in Most Categories

Across the seven fund categories and four investment horizons studied, 23 of the 28 results showed higher asset-weighted returns than equal-weighted returns, indicating that larger funds outperformed smaller ones in general.

Conclusion

Some market participants may hope that they are able to find outperforming active managers. Our SPIVA scorecards continue to highlight the difficulties of beating the benchmarks, and Canadian active funds are no exception.

Bullish sentiment propelled the S&P GSCI higher by 16.4% in May, its best monthly performance in 11 years. The broad commodity index’s more than 50% exposure to energy was a key contributor to its performance. Energy led the way, with the WTI-based S&P GSCI Crude Oil up 55.0%, bouncing impressively off the lows in April. Despite economic data points, like U.S. consumer spending dropping the most on record, commodities posted an overall strong month. Industrial and precious metals exhibited positive gains, while agriculture and livestock were mixed.

The S&P GSCI Energy rose 35.2% in May, completely retracing the poor performance in April. As countries slowly opened from lockdowns, expectations of a pickup in demand coincided with voluntary and involuntary production cuts. Already in a dire situation pre-pandemic, there are now expectations for a wave of bankruptcies in the U.S. shale space, further adding to the production cuts. Markets will be focused on the June OPEC+ meeting for clues regarding further coordination to rebalance the oil markets. The S&P GSCI Natural Gas was the one laggard in the energy space, down 16.7% on the month, due to drastically less seasonal demand and rumblings of storage space becoming increasingly full.

In the metals complex, all eyes were on iron ore, with the S&P GSCI Iron Ore jumping 23.4%. Growing fears about the security of Brazilian iron ore exports, given the growing number of COVID-19 infections among miners, combined with strong Chinese demand for the steel-making ingredients to push iron ore prices through the USD 100 per ton level at the end of May for the first time in 10 months.

The S&P GSCI Precious Metals rose 4.2% in May. While gold continued its impressive rally, it was silver that shone brightest over the month. The S&P GSCI Silver rallied 23.6%, buoyed by supply disruptions due to lockdowns in major silver producing countries, such as Peru and Mexico, and strong demand for silver by silver-backed exchange-traded funds. Silver, which is used in items like microchips and solar panels, has more industrial applications than gold and tends to underperform during recessions and outperform when economies expand.

One would think with the amount of baking occurring in the U.S. during lockdown, grains would display some bullish undertones. However, this was not the case, as the S&P GSCI Grains fell 0.4% in May, with market participants focused on record U.S. supplies and the reignition of the U.S.-China trade war. The International Grains Council raised its production forecast for the 2020-2021 season by 12 million metric ton, while cutting its consumption outlook by 4 million over that period. The S&P GSCI Wheat fell 0.7% but was one of the only commodities with YTD performance down only single digits.

The S&P GSCI Livestock gained 5.4% last month, with the S&P GSCI Live Cattle surging 10.1%. After posting a new 10-year low in April, the same week WTI prices dipped into negative territory, steer prices bounced back, as meatpacking plants in the U.S. dealt with bottlenecks caused by worker cases of COVID-19, while meat demand remained resilient.

The S&P 1500 serves as both a benchmark indicator for U.S. equity market performance and as a basis for passively replicating investment products that aim to deliver a “market” return.  Our new paper examines the index from both these perspectives, and compares the S&P 1500 with other U.S. equity market indices.  Here are a few takeaways.

The S&P 1500 offers a more holistic assessment of the U.S. market.

Many investors look to the S&P 500 to gauge U.S. market performance, with more than USD 9 trillion being indexed or benchmarked to the index as of the end of 2018. However, by looking beyond the S&P 500, the S&P 1500 offers perspectives on a broader range of market narratives. Indeed, S&P MidCap 400 and S&P SmallCap 600 constituents are typically more sensitive to the U.S. economy, and differences in sector allocations can help to diversify large-cap sector exposures.

The S&P 1500 benefitted from its exposure to smaller companies.

Students of financial theory will be well-versed in the “small size” premium: the observation that smaller companies have typically outperformed their larger counterparts.  This premium can be seen when looking at historical returns: the S&P 400 and the S&P 600 outperformed over longer horizons, which in turn helped to explain why the S&P 1500 beat the S&P 500 over the same horizons.

Combined with the fact that most active managers have typically found it difficult to outperform these indices – on an absolute or risk-adjusted basis – the S&P 1500 may be an appealing option for those looking to access the U.S. equity market.

The S&P 1500 Avoids Less Liquid, Lower Priced, and Lower Quality Stocks That Are Specific to the Russell 3000

Market participants can choose from several indices to track the performance of U.S. equities.  For example, the Russell 3000 index measures the performance of the 3,000 largest U.S. companies, subject to certain criteria.  Although sizeable overlaps in mega-cap names meant that the S&P 1500 and Russell 3000 posted similar risk/return profiles, it is important to remember that the two indices are constructed differently.

For example, the S&P U.S. equity indices incorporate an earnings screen whereas their Russell counterparts do not.  One way to see the impact of this earnings screen is to compare the characteristics of S&P 1500 stocks with “Extra 1500” stocks.  The latter group consists of the largest 1,500 U.S. stocks that were not members of the S&P 1500, with around 85% being iShares Russell 3000 ETF constituents at the end of April.

Exhibit 3 suggests that investors may find it more difficult to trade stocks that are specific to the Russell 3000 and may be more likely to encounter capacity constraints: the “Extra 1500” stocks are less liquid, lower priced, and of lower quality.

Taken together, the S&P 1500 is a more representative benchmark for those wishing to seek the returns of the U.S. equity universe but wanting to avoid additional trading and implementation costs coming from the additional 1500 securities.

S&P Dow Jones Indices recently published its fifth annual analysis of exchange-traded fund (ETF) usage by U.S. insurers in their general accounts. Regulatory filing data, which details the individual securities that insurers hold, showed that in 2019, ETF AUM in insurance general accounts grew to USD 31 billion—a 16% increase over 2018. While this headline figure shows the continued growth of ETFs in insurers’ portfolios, the trends that underlie this data are perhaps more interesting.

Insurers Sold ETFs That Weren’t Equity or Fixed Income

The number of ETF shares insurers held declined in 2019 to 398 million from 400 million in 2018, indicating that while AUM grew, insurers were net sellers of ETFs in 2019. If we break down the data in terms of asset class, however, we see that insurers bought equity and fixed income ETFs and sold ETFs classified as “other,” a category that includes currency, commodity, multi-asset, etc. Insurers’ holdings of non-equity and non-fixed income ETFs saw a 38% year-over-year decrease in AUM and a 45% decrease in shares. Exhibit 1 shows how each asset class contributed to the change in insurers’ ETF shares from 2018 to 2019.

Life Insurers, in Particular, Sold ETFs

If we look at what drove the decline in insurers’ ETF shares now in terms of company type versus asset class, we see that while Property and Casualty (P&C) and Health companies were net buyers of ETFs in 2019, Life companies were net sellers (see Exhibit 2).

Life insurers sold fixed income ETFs last year, a reversal in the significant buying that took place between 2015 and 2017 (see Exhibits 3.1 and 3.2).

Most of Insurers’ Fixed Income ETF AUM Was in IG, but High Yield (HY) Gained Traction

Fixed income ETF usage within insurance general accounts overall, however, continues to grow, with AUM up 13% year-over-year and shares up 11% year-over-year. While nearly 80% of insurers’ fixed income ETF AUM was in investment-grade bond ETFs, HY bond ETFs are gaining traction, particularly with P&C insurers, which increased their buying of HY bond ETFs by 169% in 2019 (see Exhibit 4).

HY bond ETFs comprised 38% of P&C insurers’ fixed income ETF holdings—more than four times the percentage of the broader insurance market’s HY bond ETF holdings.

We offer these insights with the caveat that much has changed this year in the financial markets, and as a result, insurers’ ETF holdings may look quite different today than they did at the end of 2019. We’ll be taking a closer look at the quarterly data and publishing a companion to this report to better understand how COVID-19 may have affected insurers’ holdings.

In March, COVID-19 inspired volatility roiled markets across the globe. Similarly, the volatility of the S&P/TSX Composite also jumped. The increase, however, was not balanced across all sectors. We see this manifested in the most recent rebalance for the S&P/TSX Composite Low Volatility Index.

Effective after the close of trading April 24, 2020, Exhibit 1 reflects the sector allocation of the low volatility index. Thirty of the 50 names were replaced in the index, for a weight change of 56%. (For context, median annual turnover for the index is 60%.) Needless, to say this reflects a quarter of major commotion.

Notably, we saw a significant scaling back of Real Estate (-16%), Utilities (-12%), and Financials (-11%). In their place, Industrials (+19%) and Consumer Staples (+10%) rose as the two highest allocations of the index.

S&P DJI’s low volatility methodology does not apply constraints around sector allocations.  Though the low volatility index searches for the lowest volatility at the stock level, sector allocations (as shown in Exhibit 2) can sometimes offer context around where things are relatively more stable. Not surprisingly, Energy, Utilities, and Financials experienced the biggest spikes in volatility, and all are on the higher end of the volatility spectrum while Consumer Staples and Industrials are relatively less volatile.