Indexology^® Blog

S&P Dow Jones Indices (S&P DJI) and BMV recently launched the long-awaited S&P/BMV Total Mexico ESG Index to great fanfare. The Mexican equities market is in the early stages of exploring ESG-related concepts, from sustainable assessments at the issuers’ level to sustainable investments for asset owners, asset managers, and regulators. The S&P/BMV Total Mexico ESG Index, which uses the world-renowned Corporate Sustainability Assessment (CSA) from SAM (part of S&P Global), is a local index that employs the latest international standards and best practices.

The following statistics aim to highlight the main characteristics of the S&P/BMV Total Mexico ESG Index:

• The index currently includes 29 constituents, but this amount can change during its annual rebalancing. Of these constituents, 23 are also in the S&P/BMV IPC. One of the main differences with the S&P/BMV IPC is that the S&P/BMV Total Mexico ESG Index includes FIBRAS (REITs) in order to recognize these companies from an ESG perspective;
• As of July 20, 2020, the S&P/BMV Total Mexico ESG Index represented 68% of the market cap of the S&P/BMV IPC;
• The weight of the largest constituent was 6.9% as of July 20, 2020, while the largest company in the S&P/BMV IPC was nearly 16% of the index;
• The S&P/BMV Total Mexico ESG Index has an ESG profile that is 17 points higher than its benchmark index, the S&P/BMV Total Mexico Index. This represents a maximum potential increase in its ESG profile of 43% over the benchmark;
• Looking at sector diversification, we find that nine GICS^® sectors are represented in the index (see Exhibit 1).

How many of the constituents in the S&P/BMV Total Mexico ESG Index are included in the other S&P ESG Indices? Let’s see: 15 constituents of the S&P/BMV Total Mexico ESG Index are also constituents of the Dow Jones Sustainability MILA Pacific Alliance Index (55 constituents)—this is noteworthy considering that the methodology of each index is different per the following:

• The Dow Jones Sustainability MILA Pacific Alliance Index is a best-in-class methodology in which the top 30% per industry are selected; while
• The S&P/BMV Total Mexico ESG Index seeks to be aligned with the principal sustainability criteria. The index applies exclusions based on certain business activities and non-compliance with the UN Global Compact criteria. It is weighted by S&P DJI ESG score.

In addition, three companies in the S&P/BMV Total Mexico ESG Index are also members of the Dow Jones Sustainability Emerging Markets Index, which has 97 constituents in total.

Finally, it is important to mention that of the 29 index constituents, 26 completed the SAM CSA, while for the remaining three constituents, SAM performed the evaluation using their public information.

Considering these points, we see the S&P /BMV Total Mexico ESG Index complies with the characteristics of liquidity, representation, replicability, and diversification, which could allow it to be used as benchmark or in financial products such as ETNs.

I would like to acknowledge Silvia Kitchener for her contribution to this blog.

The S&P GSCI rose 3.8% in July 2020, taking its YTD performance to down 33.9%. Weakness in the U.S. dollar against a range of currencies supported commodities. The broad U.S. dollar fell to a two-year low at the end of the month. Lower real rates, a weaker dollar, and widespread fiscal and monetary stimulus measures continued to boost demand for precious metals, which are considered a hedge against inflation and currency debasement.

Following the volatility of the first six months of 2020, July proved rather subdued for the global energy complex. The S&P GSCI Energy up was 2.6%, buoyed by a weaker U.S. dollar. But the ongoing recovery in oil demand remains tempered by continual concerns over the recovery of the global economy, in light of a second wave of COVID-19 in many parts of the world. From a supply perspective, bloated U.S. crude oil inventories have finally started to fall, while OPEC’s decision to ease production curbs offers them some flexibility should demand weaken further.

Continued positive economic data out of Asia boosted the S&P GSCI Iron Ore by 14.4% and the S&P GSCI Industrial Metals by 6.7% in July. The positive demand for iron ore out of China continued as the country increased spending on infrastructure to fight the economic shock from the pandemic. The S&P GSCI Zinc fully recovered from the drop in H1 2020 and outperformed the other industrial metals that make up the S&P GSCI Industrial Metals over the month, ending up an impressive 13.2%.

The less-precious metal, the S&P GSCI Silver, jumped higher in July, up 30.0%, after flat performance in the first half of the year. A pickup in industrial uses of silver and a new all-time high for spot gold helped the precious metal post a month-to-date performance almost double the next closest S&P GSCI constituent. The S&P GSCI Gold continued its march higher in July, rising 8.6% over the month. The ongoing rally in gold is likely a sign that investors are suffering a new bout of nerves over the outlook for the global economy and a second wave of COVID-19 cases.

The S&P GSCI Softs rose 7.5% in July, continuing to chip away at the negative YTD underperformance. Most of the heavy lifting was done by the S&P GSCI Coffee. The hardest hit of the softs so far in 2020, S&P GSCI Coffee gained 17.8% in July on the back of concerns that the pandemic was spreading in the coffee growing regions of Vietnam. With hotspots in South America still raging, concerns are mounting that coffee supplies may be affected.

The S&P GSCI Livestock recovered some ground in July, ending the month up 6.1%. The S&P GSCI Live Cattle rallied 7.2% on the back of a long-awaited uptick in weekly beef export sales and improved U.S. summer grilling demand.

The S&P ESG Global Macro Index is designed to capture potential opportunities across market conditions through a rules-based, geographically diverse, dynamic mix of ESG equities and fixed income.

In politics, “regime change” denotes the replacement of one governmental structure with another; in economics, we use the same term to indicate a shift in the interactions of various parts of the economic or financial system. Political regime changes are easy to identify (after all, a military coup is hard to miss).  Defining when an economic regime change has occurred can be more difficult.  One way to do it is to observe the interaction of sector and factor indices.

In the first six months of 2020, there were major changes in sectoral volatility.  Exhibit 1, which shows factor tilts relative to the S&P Composite 1500® benchmark, demonstrates the changes in the Real Estate and Utilities sectors, both of which are traditionally defensive. Both of these sectors decreased their exposure to the low volatility factor (from well above average to neutral), and simultaneously experienced an increase in their tilt towards high beta (from well below average to neutral).

Source: S&P Dow Jones Indices LLC and FactSet. Data as of January and June 2020. Chart is provided for illustrative purposes.

In contrast, Exhibit 2 illustrates that traditionally riskier sectors like Health Care and Technology moved in the opposite direction – increasing their tilt towards low volatility, decreasing their tilt towards high beta, or both.

Source: S&P Dow Jones Indices LLC and FactSet. Data as of January and June 2020. Chart is provided for illustrative purposes.

What these exhibits demonstrate is that we have witnessed a major shift in the location of both low volatility and market sensitivity.  “Risk off” sectors from a year ago have become riskier; last year’s “risk on” sectors have become, if not defensive, at least much less aggressive.

Sector indices are, in one sense, an ideal vantage point from which to observe market regimes because their turnover is very low. A utility remains a utility, and a technology company a technology company, regardless of the market’s cycles; when we observe changes in a sector index, as in Exhibits 1 and 2, we’re observing changes in a largely constant set of stocks.  These exhibits, in other words, tell us that relatively static sets of stocks experienced large changes in factor exposures.  We might therefore expect that the relevant factor indices would witness very large changes in sector exposures.

As indeed they did. As a result of the May rebalance, the S&P 500 Low Volatility Index decreased its weight in Real Estate and Utilities and increased its weight towards Consumer Staples and Health Care. The S&P 500 High Beta Index reduced its weight in Information Technology and increased its weight towards Financials. These sector shifts led to record turnover for these indices of 65% and 56%, respectively.

The size of these shifts isn’t surprising. Factor indices, after all, embody their factors “perfectly” only when they’re rebalanced; after that, the factor index and the factor itself can drift apart.  Other things equal, drift will be higher when the market’s dispersion is high, as it was earlier this year; the higher the drift, the larger the subsequent rebalance must be.

Sectors and factors are different ways of viewing the world, but they are not mutually exclusive. Seeing both perspectives helps us to understand market regime changes as they occur.

In our paper “How Smart Beta Strategies Work in the Australian Market,” we examined the long-term performance characteristics of S&P DJI’s Australian factor indices in different market trends. In the first half of 2020, the Australian equities market had a roller coaster response to the coronavirus outbreak, global market crash, and government stimulus packages. While most of the factor indices behaved similarly to their long-term performance characteristics, some did not. In this blog, we divided the first six months of 2020 into three time periods based on the varying price trends of the S&P/ASX 200 and reviewed how the Australian factor indices reacted in each of these different periods with the decomposition of their returns based on factor attributions for periods.

Despite the worldwide spread of coronavirus, the Australian equities market gained 7.5% during the period from Dec. 31, 2019, to Feb. 20, 2020, largely supported by the stronger-than-expected economic data. Apart from the S&P/ASX 200 Momentum, which gained 11.3%, the rest of the S&P DJI Australian factor indices underperformed the S&P/ASX 200.

Momentum and quality factors have historically tended to outperform their benchmarks during uptrend markets. According to the factor attribution shown in Exhibit 3, style factors (especially medium-term momentum), industry biases, and stock-specific risk all positively contributed to the S&P/ASX Momentum return and resulted in strong outperformance during this period. For the S&P/ASX 200 Quality Index, despite the positive return impact contributed by style factors, industry biases (overweight in Steel and Insurance and underweight in Banks and REITs) and stock-specific risks were unfavorable for the S&P/ASX Quality Index return, and the index underperformed slightly for the period.

With increasing concerns about the coronavirus outbreak, global recession, and disruption to corporate supply chains and sales, the Australian market experienced a sharp decline starting on Feb. 20, 2020, together with the global stock market crash and oil price decline. Over the period from Feb. 20, 2020, to March 23, 2020, the S&P/ASX 200 dropped 35.9%. According to the factor index research outlined in our paper, quality and low volatility indices tended to outperform while value and small-cap indices tended to lag the benchmark during bearish markets.

During this market decline, most factor indices’ performances tended to align with their long-term characteristics. However, we noticed that the outperformance of the low volatility index was not as pronounced as what we saw in previous market sell-offs. According to the factor attribution, both the style factor exposures and stock-specific risk positively affected the return of the S&P/ASX 200 Low Volatility Index. However, the strong industry bias to REITs (one of the worst-performing industries during this period) severely dragged the index return and eroded the outperformance of the index.

Following a series of health and safety measures (closing borders, imposing social distance rules), interest rate cuts, and government stimulus and subsidy packages, the S&P/ASX 200 started to rebound after touching its lowest point on March 23, 2020. The S&P/ASX 200 posted a gain of 30.1% during the market rally from March 23, 2020, to June 30, 2020. Historically, momentum, quality, and small-cap indices tended to outperform their benchmarks, while value, dividend, and low volatility tended to underperform during bullish markets. However, in this recent rally, the S&P/ASX Quality Index underperformed the S&P/ASX 200 by 3.8% while the S&P/ASX Dividend Opportunities Index outperformed by 2.3%.

For the S&P/ASX 200 Quality Index, the targeted exposures to profitability and leverage, as well as the industry biases, contributed positively to the index return. The unintended exposure to short-term momentum negatively affected the index, resulting in underperformance. For the S&P/ASX Dividend Opportunities Index, the dividend yield and value factors generated negative returns in this period, though the industry biases (underweight in Consumer Staples and REITs; overweight in Metals & Mining [ex-Gold & Steel], Utilities, and Consumer Discretionary) and stock-specific risk contributed positively to the dividend index performance and led to index outperformance.

Overall, the S&P/ASX 200 Momentum and S&P/ASX 200 Quality Index were the best-performing Australian factor indices in the first half of 2020, while the S&P/ASX 200 Enhanced Value performed the worst. Most factor indices aligned with their long-term cyclical characteristics, with a small number of them showing different behavior largely due to industry biases and unintended factor exposures.