Indexology^® Blog

The year 2020 has brought about many unexpected turns of events. The COVID-19 pandemic, which will be marked in history as one of the most-acute pandemics that the world has had to experience, is one.

Another area that has seen a transformation in the financial investing space is the realization and acceptance of passive investing. The recent growth trends globally and in India are marking new trajectories. The global growth story in passive products has been strong and broadening, with new innovations and themes. India has played catch-up, with the exponential growth in assets in the past few years revealing the potential for the passive space in the region.

As of March 2020, global assets in passive products passed USD 5 trillion, with over 7,000 passive products. The U.S., with a market share of 68%, USD 3.6 trillion in assets, and over 2,000 products, is followed by Europe and Japan with 16% and 6.5% of market share, respectively. The global asset mix is skewed toward equities, leading with a 70% share in assets at USD 3 trillion, followed by fixed income with a 21% share at USD 1 trillion.

For India, though the numbers are far more modest, the growth has been encouraging, with the total assets under management in passive products at USD 24 billion and 86 passive products. Five years ago, the scenario in India included a mere USD 2 billion in assets and 57 products. A decade back had far less, with USD 1 billion and 26 products in the market. Hence, the progress made by the country has been remarkable, especially in the backdrop of a faster-paced active investing market. Two years ago, the exchange-traded fund market constituted 2.2% of the mutual fund industry, while in December 2019, it stood at 7.5%.[1]

Global themes in passive products have progressed from plain vanilla asset classes, geographies, segments, and market benchmarks to factors that could be single or multi-factor, thematic-like infrastructure or corporate clusters, sustainability (a popular and fast-growing segment), and so on. Furthermore, advanced concepts are being explored via indices, such as new economies. For example, the S&P Kensho New Economies Indices are a family of indices tracking the industries and innovations of the Fourth Industrial Revolution.

Rapid developments in artificial intelligence and robotics, coupled with exponential processing power and ubiquitous connectivity, are driving structural changes in the global economy, disrupting existing industries and forging new ones. The S&P Kensho New Economies Composite Index is designed to measure the performance of companies involved in the New Economies 21st Century Sectors, including a dynamically adjusted list of companies drawn from all of the S&P Kensho New Economy subsector indices. The S&P Kensho New Economies Select Index measures a subset of the five best-performing subsector indices.

These new innovative indices are breaking grounds in investment themes and products that offer further variety to portfolio strategies.

[1] Source: https://etfgi.com. March 2020.

In the first quarter of 2020, the global economy experienced not a slowdown, but a shutdown. As COVID-19 swept the world, outsized market movements became the new norm. The S&P 500^® finished its worst quarter (-19.6%) since 2008’s global financial crisis. International equities fared even worse as the S&P International 700 lost 22.4%. While investors were catching their breath after the February-March sell-off, the S&P 500 rebounded in April and posted its largest monthly gain (12.8%) since 1987.

Active managers sometimes seek to soften the conclusions of our regular SPIVA^® reports by arguing that, while index funds may have the advantage in rising markets, it’s in volatile downturns that active management can prove its worth. Historical data argue otherwise,[1] and most active managers continued to underperform in 2020.

Of domestic equity funds, 64% underperformed the S&P Composite 1500^® in the first four months of 2020, and 67% underperformed in the past two quarters. During the one-year period ending March 2020, 72% of domestic equity funds underperformed, slightly worse than the year-end 2019 result (70%).

Most large-cap funds underperformed the S&P 500 across all time horizons. The consistency of their underperformance in the first quarter market decline and the April rebound was especially noteworthy. During Q1 2020, 54% of all large-cap funds underperformed; in April, the YTD underperformance percentage increased to 59%. We also observed this pattern in other categories, highlighting the difficulty in market timing.

Short-Term Success versus Long-Term Underperformance

Unsurprisingly, SPIVA results are noisier for shorter time horizons. Although we see pockets of relative success for active managers up to three years, over the long term, they still generally lagged their benchmarks.

In the large-cap space, the only bright spot was large-cap growth, where 75% outperformed in the past two quarters. However, short-term success didn’t compensate for previous underperformance. For the past 15 years, 91% lagged the S&P 500 Growth. Mid-cap and small-cap funds were similar: 64% of all mid-cap and 57% of all small-cap funds beat their benchmarks in the past two quarters, aided by the superior performance of larger names. Their short-term success had little impact on their long-term scores though: 82% underperformed over the past 15 years in both categories.

A similar story occurred in international equities and fixed income. Despite the short-term success of global funds and international small-cap funds, most managers lagged their indices across all categories for any periods three years or longer.

Conclusion

Early 2020 results rebut the view that active funds navigate market turmoil better than index-based funds. Even where results are relatively favorable, the data show the difficulty of market timing. Mixed results in the short term did not change active funds’ tendency to underperform indices over the long term.

Learn more during our webinar on June 30, How Has COVID-19 Affected Active vs. Passive Performance?

[1] 65% of domestic equity funds underperformed the S&P Composite 1500 in 2008.

Has the IT sector done well because of the quality factor, or is it the other way round? S&P DJI’s Anu Ganti takes a closer look at the relationship between sectors and factors to explore what’s driving IT’s climb over the past 12 months.

Read the blog: https://www.indexologyblog.com/2020/05/27/symbiotic-sentiments/ 

Target date funds have seen tremendous growth. At the end of 2019, assets in target date mutual funds reached nearly USD 1.4 trillion, impressive growth from USD 256 billion a decade ago.[1] Other than a brief dip in the fourth quarter of 2018, the growth of assets has been fairly stable with an upward trajectory (see Exhibit 1).

Several variables drive this sustained growth. Target date funds are used by many plan sponsors as one of the qualified defined investment alternatives (QDIA)[2] under Department of Labor regulations. At the same time, the burden of saving adequately for retirement now falls squarely on employees as plans shift from defined benefit structures to defined contribution structures. That means that relatively unsophisticated plan participants need to make investment decisions on asset allocation and portfolio construction. Against that backdrop, it’s not surprising to see target date funds gaining traction among defined contribution plans, as they offer a one-stop shop solution. They are often the default investment option on employer retirement plans.

There is fair degree of heterogeneity in target date funds’ construction, leading to substantial dispersion in realized returns even within the same category. Returns differ for several reasons:

• Different glide path construction, which determines how asset allocation shifts over time;
• Capital markets assumptions; and
• Asset classes used.

For example, the spread between the 90^th percentile fund and the 10^th percentile fund for the 2020 target date vintage is nearly 507 bps. The spread varies with the year, but the average across all vintages amounts to approximately 430 bps (see Exhibit 2).

In an extreme scenario, consider two plan participants entering the workforce at two different firms at the beginning of 2020, with each having an identical 40-year time horizon. Each participant enrolls in a 2060 target date fund offered by their respective firm. Additionally, if we further assume that one fund is in the top decile while the other is in the bottom, then the difference in compounded returns between the top- and bottom-decile funds over a 40-year working life[3] could be as much as 400% on a cumulative basis. Therefore, performance drag can make a meaningful difference in determining whether a participant has adequate savings for retirement.

All of this raises the issue of how to evaluate the performance of a target date fund. Target date funds are sometimes benchmarked to a static portfolio with fixed weights of equity and bonds, such as a 60/40, or in an egregious case, simply to the S&P 500^®. Neither one is truly reflective of a fund’s objective or reflective of the outcome investors receive.

Employees nowadays face the difficult burden of saving adequately for their retirement years. Target date funds are innovative solutions providing pre-packaged investment decisions that plan participants would otherwise have to make. Unfortunately, there is no uniformity when it comes to the construction of target date funds, making it difficult to determine whether the funds are truly delivering for their plan participants. Independently calculated and governed target date benchmarks, like those offered by S&P DJI, fill that gap by providing transparency and easy performance attribution.

[1] Based on quarterly assets data from the Investment Company Institute.

[2] A QDIA is a default investment option chosen by a plan fiduciary for participants who fail to make an election in their investment accounts.

[3] We assume that the top-decile and the bottom-decile target dates remain in their respective deciles over the course of the 40-year horizon and maintain the 2060 vintage spread of 3.58%. The difference is then compounded over the 40-year horizon.

It’s time to look at dividend indices through the lens of these “unprecedented times.” Many market participants seek the comfort of dividend strategies, precisely for the yield they can generate. However, dividend investing is under siege, since many companies have announced reduced dividends or have suspended them altogether given the impact of the COVID-19 pandemic on the global economy. A crystal ball might come in handy to foretell the future. In the absence of that, we can look at historical periods of financial crisis to see how these strategies performed.

Exhibit 1 focuses on the Global Financial Crisis (GFC) of 2008, which shows that during mid to late October 2008, the main country benchmarks in Mexico, Chile, and Brazil declined substantially. However, with the exception of the S&P/BMV Dividend Index, the other local dividend indices outperformed their respective benchmarks. The S&P Dividend Aristocrats^® Brasil and the S&P Brazil Dividend Opportunities outperformed the S&P Brazil LargeMidCap Index by 11.6% and 14.0%, respectively.

Not only did most dividend indices fare relatively well compared with their respective benchmarks during the GFC, but in all cases, the strategies recovered faster and, in some cases, much faster. In Mexico, the total return version of the S&P/BMV IPC took 139 days longer to recover than the S&P/BMV Dividend Index. The S&P Dividend Aristocrats Brasil Index and S&P Brazil Dividend Opportunities each took around a year to recover, while, shockingly, the benchmark took nearly eight years to achieve a new peak after the drawdown.

Was this a unique outcome tied to the GFC? Not necessarily. Exhibit 2 gauges the period between 2010 and 2012 to capture the period during Black Monday,[1] and it paints a similar picture as that of the GFC. However, in this case, all dividend indices outperformed their respective benchmarks and recovered much faster too.

What happens when the events are more local? Exhibit 3 confirms similar results. In January 2014, a sharp devaluation of the Chilean peso against the U.S. dollar and the general loss of confidence in emerging markets caused a significant drawdown in Chilean equities. In January 2016, due to crude oil prices falling sharply, Peru and Brazil displayed major drawdowns.

In conclusion, history shows that dividend indices in Latin America were generally able to ride out unprecedented times better than their benchmarks. While past performance is certainly no crystal ball, it may provide useful context.

[1] The Black Monday crash of Aug. 8, 2011, refers to the time when the U.S. sovereign credit rating was downgraded by S&P Global Ratings for the first time in history.