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Continued Dominance of Growth Style Investing

Not a Coincidence

Assessing Gold’s Ascent

Is the S&P 500 Doing Its Job?

Did Australian Active Funds Outperform Benchmarks amid the COVID-19 Pandemic?

Continued Dominance of Growth Style Investing

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Hamish Preston

Associate Director, U.S. Equity Indices

S&P Dow Jones Indices

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Growth style investing has outperformed value for over a decade but its relative returns against value so far in 2020 have been unprecedented: the S&P 500® Growth index boasts its highest-ever year-to-date relative returns (+32%) versus its value counterpart through the third quarter. This comes despite growth’s eight-month winning streak coming to an end in September.

Amid declining interest rates earlier this year and growth companies’ higher sensitivities to discount factors, it is perhaps unsurprising that growth’s year-to-date relative returns have been driven by the outperformance of the most growth-like names in the market. Indeed, the total index market capitalization of “pure growth” S&P 500 companies—those with a growth exposure score of one, meaning they have 100% of their free-float market capitalization allocated to the S&P 500 Growth index—rose by nearly USD 3 trillion in the first three quarters of 2020. This increase was larger than the United Kingdom’s USD 2.2 trillion index market capitalization in the S&P Global BMI at the end of September.

In comparison, the collective index market capitalization of “pure value” companies dropped by USD 1.64 trillion since the end of 2019, and there were declines of USD 0.09 trillion for “middle” companies – those whose capitalization is distributed between the S&P 500 Growth and Value indices.

Much has been written recently about the outperformance of the largest names in the market in 2020, prompting concentration concerns by some market participants. Exhibit 3 shows that the five largest companies in the S&P 500 currently account for around 23% of the index, similar to the levels observed in the 1970s and up from 17% at the end of 2019.

Given that all five of the largest names in the S&P 500 are classified as “pure growth” companies, their outperformance also led to higher concentration in the S&P 500 Growth index. Exhibit 4 shows that the Herfindahl- Hirschman Index (HHI) for the growth index reached an all-time high at the end of August, with the five largest names in the index accounting for nearly 39% of the index.  In contrast, the HHI measure for the value index hit an all-time low earlier this year.

For active managers looking to deliver excess returns over the benchmark, elevated index concentrations means having (correct) views over the fortunes of the largest index constituents—and changing allocations accordingly—is more valuable. Results from our Mid-Year 2020 U.S. SPIVA® Scorecard suggest that many active managers correctly identified this year’s growth trends and over-weighted the largest, most growth-like companies in the market: 75% of U.S. large-cap growth equity funds beat the S&P 500 Growth Index over the 12-month period ending June 30, 2020.

In contrast, over 70% of large-cap value managers underperformed the S&P 500 Value index over the same horizon.  Much lower levels of index concentration and the more varied reactions of the value index’s constituents amid the “COVID correction” appeared to make it more difficult to identify trends in value.

As a result, the outperformance of the largest, most growth-like names in the market has propelled growth to its record-breaking relative returns compared to value, and appeared to help many growth managers to outperform recently. However, SPIVA results show how difficult it has been for active managers to outperform across the size and style spectrum, especially over longer horizons, and our Fleeting Alpha report shows that past (out)performance is no guarantee of future results. In other words, it is worth remembering that the index advantage is not a coincidence.

The posts on this blog are opinions, not advice. Please read our Disclaimers.

Not a Coincidence

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Craig Lazzara

Managing Director and Global Head of Index Investment Strategy

S&P Dow Jones Indices

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We recently issued our mid-year SPIVA® reports for the U.S., Australia, and Europe, and other regions will follow in due course. Although one can sometimes find exceptions in the short run, the long-term results of SPIVA can be easily summarized:

  • The majority of active managers underperform most of the time.
  • Historical success does not predict future success.

SPIVA continues a line of inquiry that began nearly 90 years ago with the first study of active fund performance versus passive benchmarks. This work accelerated in the 1970s, as the growth of professional portfolio management drew increasing academic interest. Nobel laureate Paul Samuelson was representative of his contemporaries in suggesting that “most portfolio decision makers should go out of business.”

Active managers didn’t take kindly to Samuelson’s suggestion in 1974 and, despite the accumulation of confirming evidence since then, they don’t take kindly to it today either. We’ve estimated that the cumulative cost savings to asset owners just from indexing the S&P 500®, S&P MidCap 400®, and S&P SmallCap 600® amount to better than $300 billion, and every dollar of costs saved by the investor is a dollar of fees not paid to an active manager. So while resentment is to be expected, it’s surprising that critics of SPIVA sometimes focus on its minutiae, rather than on its results.

The most important thing to realize about SPIVA results is that they are not a coincidence. The active management community didn’t lose a cosmic coin flip 90 years ago; active underperformance happens for a set of readily identifiable reasons. These include:

Professionalization. Portfolio management is a zero-sum game; the only source of alpha for the winners is the negative alpha of the losers. When most of the assets in a market are professionally managed, the average professional won’t beat the market because the average professional is the market. It’s not a coincidence that the first index funds were launched in the 1970s; by that point the U.S. equity market had been largely professionalized.

Cost. The expense ratio of the average actively-managed equity mutual fund was 0.74% in 2019; the average index fund cost 0.07%. The average active manager therefore starts out 67 bps in the hole.

Skewness. The distribution of stock returns is skewed—i.e., most stocks underperform the market average. Exhibit 1 illustrates this for the S&P 500.

Of the 1,010 stocks that were part of the S&P 500 between 2000 and 2019, only 267 returned more than average. The probability that a randomly chosen stock would deliver above-average performance, in other words, was 26%, not 50%. When fewer stocks outperform, active management is harder.

These (and other!) reasons are robust and sustainable. Investment management will stay professionalized, active costs will always exceed index costs, and in most years most stocks underperform the average in most markets. The index advantage is likely to persist.

The posts on this blog are opinions, not advice. Please read our Disclaimers.

Assessing Gold’s Ascent

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What’s driving demand for gold this year? S&P DJI’s Jim Wiederhold and CME Group’s Blu Putnam explore what’s pushing gold prices up and how investors are putting the precious metal to work in portfolios.

The posts on this blog are opinions, not advice. Please read our Disclaimers.

Is the S&P 500 Doing Its Job?

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Raymond McConville

Communications, Americas

S&P Dow Jones Indices

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On Sept. 4, 2020, S&P DJI’s U.S. Index Committee announced that Etsy, Teradyne, and Catalent were being added to the S&P 500®, replacing H&R Block, Coty, and Kohl’s.

The changes attracted significant market attention and sparked a discussion around the names being added to the index, as well as those that were not. These updates also coincided with the S&P 500’s scheduled quarterly rebalancing. Changes to the index can be made at any time—they do not have to happen during quarterly rebalances. However, given the higher-than-usual attention, it’s worth revisiting the S&P 500’s purpose and objective, what the Index Committee does, and how the committee helps ensure that the index is doing its job.

What Is the S&P 500’s Objective?

The S&P 500 is synonymous with U.S. equity market performance and is referenced by investors, analysts, and the media every day. The index was up 1.5% today? Great, the S&P 500 is doing well! Did the market decline? Uh-oh, the S&P 500 did poorly. But whether the index is “doing a good job” has little to do with the direction of its returns.

Per the S&P U.S. Indices Methodology, the objective of the S&P 500 is to “measure the performance of the large-cap segment of the U.S. market.” That’s it. The job of the Index Committee is not to add stocks that it thinks will perform well. Instead, it makes sure the index continues to provide a representative reflection of the large cap U.S. equity market.

Rebalancing versus Reconstituting

The U.S. large-cap market has changed significantly over the years and there are several ways the Index Committee ensures that the 63-year-old S&P 500 reflects that evolution. One of them is by rebalancing the index.

During a rebalance, S&P 500 constituents’ individual weights are adjusted to reflect their latest share counts and float. Company share counts are constantly changing as they issue stock and perform buybacks, so the S&P 500 is rebalanced every quarter to adjust each company’s weighting based on its latest share count and float.
While the Index Committee can also reconstitute the index during a rebalance by adding or removing companies, these changes to index membership can be made at any time—they don’t have to happen during a rebalance and a rebalance doesn’t have to include a reconstitution.

Since the beginning of 2017, 82 companies have been added to the S&P 500.

So, Is the S&P 500 Doing Its Job?

This brings us back to our first question. Have all the changes made over the years by the Index Committee helped the index accurately represent the U.S. large-cap market?

One way we can grade the S&P 500’s performance is through sector representation. Since the index has a fixed count of 500 companies, not every eligible company can be added to the index. One of the factors the Index Committee looks at when considering changes to the index is sector composition. Per the index methodology, this is measured by a comparison of GICS® sector weights in the S&P 500 with the corresponding weights in the large-cap range of the S&P Total Market Index (TMI), which measures the performance of all U.S. stocks.

Using the historical market capitalization thresholds from Appendix A of the S&P U.S. Indices Methodology document, we can arrive at the GICS sector weights for the large-cap section of the S&P TMI.

Exhibit 2 shows the relative sector weights of the S&P 500 against the large-cap portion of the S&P TMI. The average difference is based on year-end weights between 2007 and 2020.Clearly, the S&P 500 GICS sector weights have typically been similar to the large-cap portion of the S&P TMI. And while some differences have emerged in 2020, the S&P 500 remains representative of the large-cap U.S. equity space. The index is doing its job.

The posts on this blog are opinions, not advice. Please read our Disclaimers.

Did Australian Active Funds Outperform Benchmarks amid the COVID-19 Pandemic?

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Priscilla Luk

Managing Director, Global Research & Design, APAC

S&P Dow Jones Indices

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With the COVID-19 pandemic, equity markets around the world experienced massive declines with heightened volatility, and the Australian equity market was not immune. Various equity market segments experienced rapid market sell-offs followed by slow recoveries in H1 2020, with the S&P/ASX 200, S&P/ASX Mid-Small, and S&P/ASX 200 A-REIT decreasing 10.4%, 6.9%, and 21.3%, respectively.

Due to the volatile environment, stock return dispersion in global equity indices rocketed to historic highs in March,1 providing fertile ground for stock picking. Return spreads across the S&P/ASX 200 Sector Indices and S&P/ASX 200 Factor Indices were widened to 45.5% and 26.8% in H1 2020, respectively (see Exhibit 1). This market condition may prompt fund investors to question: did Australian active funds outperform benchmarks amid the COVID-19 pandemic?

The answer does not seem favorable for Australian active managers according to their fund performance versus the benchmark in H1 2020. In the recently published SPIVA® Australia Mid-Year 2020 Scorecard, we observed the majority of active funds had worse performance than their respective benchmark indices across most fund categories in H1 2020. Of funds in the Australian Equity General, Australia Equity Mid- and Small-Cap, and International Equity General categories, 64%, 56%, and 60% underperformed their benchmarks, respectively. The portion of underperforming funds was smallest in the Australian Equity A-REIT category, with 45% of funds underperforming the S&P/ASX 200 A-REIT. Australian Bonds was the only category that recorded a positive average return in H1 2020, though more than 70% of funds in this category failed to outperform the S&P/ASX Australian Fixed Interest 0+ Index.

All fund categories underperformed their respective benchmarks over the same period in terms of their equal- and asset-weighted returns. Despite mid- and small-cap funds delivering better average returns than the benchmark over longer time horizons, they recorded a larger average drawdown than the S&P/ASX Mid-Small in H1 2020. The asset-weighted returns exceeded the equal-weighted returns for the Australian Equity General and Australian Equity Mid- and Small-Cap fund categories, indicating larger equity funds tended to suffer less drawdowns during the COVID-19 crisis in these two categories.

During this volatile period, some active managers harvested the benefit of high stock return dispersion, but some were badly hurt. Equity fund return spreads were high in H1 2020, as most obviously seen among the Australian Mid- and Small-Cap funds and International Equity General funds, with the first and third quartile return breakpoints differing by 8.0 % and 8.4%, respectively. One-quarter of Australian Mid-Small-Cap funds outperformed the S&P/ASX Mid-Small by more than 2.5%, but one-quarter underperformed the benchmark by more than 5.5%. Among International Equity General funds, one-quarter delivered excess returns of more than 2.9%, though one-quarter of these funds lost more than 8.7%, which was more than double the benchmark’s drawdown (3.2%).

In our semiannual SPIVA Australia Scorecard, we have consistently observed underperformance for the majority of Australian active funds across most categories over time. The high market volatility seen during the COVID-19 crisis was an excellent time for active fund managers to reveal their portfolio skills, as record-high stock return dispersion resulted in a good opportunity for stock pickers to outperform. However, the results of the mid-year 2020 scorecard revealed that the majority of active fund managers failed to capture this opportunity.

1 For tables and charts on equity index dispersions in March 2020, see the Dispersion Dashboard: https://www.spglobal.com/spdji/en/documents/commentary/dashboard-dispersion-2020-03.pdf

 

The posts on this blog are opinions, not advice. Please read our Disclaimers.