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Latin American Equity Markets Struggled to Stay Positive during Q3 amid Broader Global Equity Market Rally

Indian Investments in Global Equities: From Zero to Hero

The S&P Global BMI’s Comprehensive Small-Cap Segment

The Unrewarded Risk of Supernormal Fund Returns

Dissecting Performance Characteristics of Growth Factors in Australian Small-Cap Equities

Latin American Equity Markets Struggled to Stay Positive during Q3 amid Broader Global Equity Market Rally

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Silvia Kitchener

Director, Global Equity Indices, Latin America

S&P Dow Jones Indices

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In Q3 2020, we saw a continuation of the technology-led global equity market rebound with the S&P 500® up 8.9%, the S&P Europe 350® up 4.3%, and the S&P Pan Asia BMI up 8.9%, while the S&P Developed Ex-U.S. BMI and the S&P Emerging BMI were up 6.3% and 9.0%, respectively. The story was different in Latin America, where the equity market has little exposure to technology-driven companies, though some markets benefited from the boom in mining stocks.

Overall, Latin American equities remained flat (-0.2%) in USD terms, as measured by the S&P Latin America BMI, a broad, regional index designed to measure the performance of 289 stocks from Brazil, Chile, Colombia, Mexico, and Peru.  However, the S&P Latin America 40, representing the 40 largest (by market cap) and most liquid stocks, dropped a full 2.0% for the quarter amid the continued ravaging of COVID-19 on public health and the local economy.

On the economic front, S&P Global Ratings’ analysts recently reported1 that Latin America is in the middle of a recovery. However, the 2020 GDP forecast for all countries in the region will remain contracted. Due to strong exports to China and less stringent lockdowns, Brazil’s economic contraction will be less severe than was originally forecasted, while other countries like Argentina, Colombia, Mexico, and Peru will be worse off than expected. Meanwhile, Chile is very much on target. Many variables will affect the depth and speed of the recovery as countries try to emerge from the worst pandemic in more than 100 years.

At the sector level, Information Technology, Materials, and Industrials were the winners, with positive returns of 19.1%, 15.2%, and 8.3%, respectively for Q3 2020. The worst performers were Energy, Utilities, and Financials, losing 9.1%, 6.8%, and 6.4%, respectively.

Argentina’s economy is one of the most affected in the region, but economists expect Q3 2020 to be the start of its gradual stabilization.2 S&P Global Ratings has raised the country’s rating based on a new proposal to restructure its debt in order to avoid another sovereign default. The S&P MERVAL Index gained 7% in ARS for the quarter, with the S&P/BYMA Argentina General Construction Index leading the sector board (up 42.5%); the biggest losses came from the Energy sector (-8.9%).

Brazil’s equity market was nearly flat, with the Brazil 100 Index (IBrX 100) and the S&P Brazil BMI gaining 0.0% and 0.7%, respectively. This may be a first step in the right direction, with the economy3 rebounding during Q3, primarily driven by increased demand in commodity and food exports. Not surprisingly, the S&P/B3 Momentum Index (up 8.5%) and the S&P/B3 High Beta Index (up 5.9%) did well. These smart beta indices are designed to measure stock performance while factoring in the sensitivity of the market and its movements. Likewise, the S&P/B3 Ingenius Index (up 21.0%) continued to generate extraordinary returns in the midst of the pandemic, benefiting from the performance of technology-driven stocks.

Chile is not only struggling with the pandemic, but it is also in the middle of a major potential political change, with an upcoming referendum for a new constitution. All this uncertainty is keeping the equity market in the red, with the S&P IPSA dropping 8.1% in Q3. S&P Global Rating’s economists, however, have been more optimistic about a quick economic recovery in Chile, given the “strong government support for labor markets and business.” Chile’s shining spot was in the mining sector, with the S&P/CLX Natural Resources Index gaining 9.6% in Q3.

Colombia and Peru generated strong results. The S&P Colombia Select Index gained 7.3% for the quarter. Among Peruvian equity indices, the S&P/BVL Peru Select 20% Capped Index was the best performer (up 9.3% in PEN and 7.4% in USD) for Q3, aided by the high returns of the mining sector, as the S&P/BVL Mining Index had double digit returns (up 20.6% in PEN and 18.5% in USD).

Mexico’s main equity indices were generally flat, with the S&P/BMV IPC losing 0.7% for Q3. The exception was the S&P/BMV IRT MidCap, which gained 10.1% for the same period. Looking at the sector indices, the story of Chile and Peru repeats itself, with the mining sector in Mexico yielding the highest return, with the S&P/BMV Materials Select Sector Index gaining 17.3%. Among other industries, FIBRAs in Mexico had a strong third quarter, with returns of 5.9%. As was the case in Brazil with the S&P/B3 Ingenius Index, the S&P/BMV Ingenius Index gained 12.0% for the quarter and 56.6% YTD.

It has been a long year and the end cannot come soon enough. As we enter the last quarter of 2020, let us hope for a speedy and strong recovery for Latin American economies, equity markets, and its people.

For more information on how Latin American benchmarks performed in Q3 2020, read our latest Latin America Scorecard.

1   Elijah Oliveros-Rosen, Latin America Senior Economist. Economic Research: Latin America’s Pre-COVID-19 Growth Challenges Won’t Go Away Post-Pandemic. Sept. 24, 2020. S&P Global Ratings.

2   FocusEconomics: Argentina Economic Outlook. Sept. 15, 2020. www.focus-economics.com.

3   FocusEconomics: Brazil Economic Outlook. Sept. 15, 2020. www.focus-economics.com.

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

Indian Investments in Global Equities: From Zero to Hero

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Koel Ghosh

Head of South Asia

S&P Dow Jones Indices

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India has been one among many countries that favor a strong home bias in their investment portfolios. There have been many theories put forth on what causes the bias and research has been undertaken to understand it. Whether it is the ease of local information access, regulatory concerns, investor preferences, cost concerns, transactional viability, or cross-border risk aversion, the mystery remains unsolved. However, its prevalence is uncontroversial: academics and practitioners agree that Indian investment portfolios have in aggregate been stable at over 99% invested in domestic assets for decades. Even today, international allocations are only a rounding error away from zero.

However, from that low base, Indian interest in global equities is on the rise—particularly when it comes to products accessing the world’s largest equity market: the U.S. Totaling more than INR 7,000 crores at the end of August 2020, the funds focused on U.S. equities have witnessed asset growth of over 400% in the past five years. Intriguingly, this growth has been supported—even led—by “passive” products (funds tracking an index), which have grown to represent over 40% of the total.

Meanwhile, although options for Indian investors are somewhat limited at present, the range of products available in the market is steadily on the rise. And against the backdrop of an INR 25.48 lakh crore mutual fund industry, there is plenty of room to grow—particularly if investors see the advantages of global diversification for balancing country risks and accessing returns.

International diversification does not have to be hard. The S&P 500®, one of the most widely used gauges for the U.S. equity market, has funds and other products tracking the index that are widely available across the globe. The index provides a simple option for diversifying country risk on a global scale: the S&P 500 represents over 50% of the global equity markets (as represented by the S&P Global BMI), while its performance versus the S&P BSE SENSEX over the past 34 years offers a clear illustration of its diversification potential.

Some may ask, isn’t index tracking settling for average performance? Not necessarily. In fact, the data points firmly in the opposite direction for large, liquid, and widely followed markets like the S&P 500. According to our SPIVA® U.S. Scorecards, a majority of active U.S. equity funds have underperformed the S&P 500 in 16 out of the 19 years since 2001.

In 2020, the performance of the U.S. stock market again emphasized its potential applications for Indian equity portfolios: YTD as of Oct. 12, 2020, the S&P 500 boasts a substantial 11% gain, despite the COVID-19 sell-off in March 2020, while the S&P BSE SENSEX has lost ground. For those Indian investors driving the trends of Exhibit 1, indices like the S&P 500 may have helped take participation up from zero to hero.

Note: Thanks to Tim Edwards for a series of conversations that generated ideas for this blog and for providing some of the accompanying data.

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

The S&P Global BMI’s Comprehensive Small-Cap Segment

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John Welling

Director, Equity Indices

S&P Dow Jones Indices

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The S&P Global BMI’s small-cap segment provides the most comprehensive measure of global small-cap securities in the market. Introduced in 1989, the S&P Developed SmallCap was the first global index covering the small-cap size range.1 At the time, international equity investing almost exclusively focused on large- and mid-cap companies, as defined by MSCI’s “Standard” index series. However, this new index offering paved the way for increased adoption of international small caps as a unique market segment. Many institutional investors now use “all-cap” indices as policy benchmarks for international equity asset classes as well, given their inclusion of dedicated international small-cap exposures.

In this second blog in a series highlighting key features of the global equities benchmark landscape, we explore how the small-cap subset of the S&P Global BMI provides unmatched breadth and flexibility to market participants in measuring the universe of global small-cap companies.

Comprehensive Small-Cap Coverage

The small-cap portion of the S&P Global BMI is defined as the bottom 15% of float market cap in each country. In addition to its extensive history, the S&P Global SmallCap offers significant depth into the market capitalization spectrum, as it reaches much further into relatively smaller constituents. As shown in Exhibit 1A, the S&P Global BMI includes more than 9,200 companies in its small-cap segment, while the MSCI and FTSE benchmarks include about 5,700 and 5,000, respectively. Exhibit 1B shows the relative size characteristics, demonstrating how the additional member count within the S&P Global SmallCap allows for extended reach, far surpassing the all-cap universe of alternatives.

Cap Range Indices Provide an Alternative Way to Measure Small-Cap Equities

While the S&P Global SmallCap, MSCI ACWI Small Cap, and FTSE Global Small Cap take a relative approach to defining company size based on the equity market composition in each country, the S&P Global BMI also offers an alternative approach to provide greater flexibility to market participants. The S&P Global BMI Cap Range Index Series breaks down the world’s stock markets according to absolute levels of total company market capitalization. For example, a popular definition of small caps is to include all companies with total market caps below USD 2 billion. This approach differs substantially from the standard relative sizing approach since a fixed market cap is applied across all global equity markets. Exhibit 2 illustrates the range of standard cap range indices included within the S&P Global BMI Index Series.

The S&P Global SmallCap has been integrated into the S&P Global BMI since its inception, creating a comprehensive all-cap benchmark exposure with historical continuity. The S&P Global SmallCap Indices are available at the country, region, and developed or emerging level, as well as in additional cap range specific segments, offering market participants a deep and flexible framework for measuring global small-cap equities. To learn more about the consistent history of the S&P Global BMI Index Series, see The S&P Global BMI: Providing Consistent Insights into Global Equity Markets since 1989.

1 The index was previously called the Salomon Smith Barney World Extended Market Index.

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

The Unrewarded Risk of Supernormal Fund Returns

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Andrew Cairns

Associate Director, Global Research & Design

S&P Dow Jones Indices

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The recently released SPIVA® Europe Mid-Year 2020 Scorecard had the unique opportunity to pit the performance of active funds against their passive benchmarks through an exceptionally rare event. The economic fallout from the coronavirus pandemic brought a period of extreme volatility, the likes of which have not been seen in Europe since the global financial crisis of 2008. In doing so, rather than highlight the opportunities available to active managers in such times, it exposed an alarming risk—a high dispersion in fund returns. In other words, there were far more occurrences of active funds significantly underperforming or outperforming their benchmark than usual.

H1 2020: A Tale of Two Quarters

The first half of 2020 can be characterized as a market crash followed by a modest recovery.

During the first three months of 2020, as the coronavirus pandemic began to wreak havoc across European equity markets, European equity funds suffered significant drawdowns. At this point, the skill of active fund managers came into question as, despite their ability to actively defend their positions, they were largely unable to avoid substantial losses.

The following three months featured a recovery in the market, following hope that the virus was coming under control and local economies were reopening. On average, European equity funds pared back their losses and recovered at a faster rate than the benchmark. However, as Exhibit 1 highlights, there was high dispersion in fund returns, indicating that the risks to active fund investors, in fact, remained high.

Mixed Fortunes for European Equity Funds

Exhibit 2 illustrates the dispersion in returns through the five different periods featured in the SPIVA Europe Mid-Year 2020 Scorecard. In each case, we can see that European equity funds largely exhibited normally distributed returns. However, there was significant variation in the tails, particularly when comparing the more recent (YTD and 1-year) returns with the annualized medium- and long-term (5- and 10-year) returns. In the short term, positive supernormal returns were rare but still possible despite volatile market conditions. However, investors hoping to grow their investment should be wary that they were just as likely to select a fund on the opposite end of the spectrum that exhibited negative supernormal returns. Furthermore, the diminishing spread between the 75th and 25th percentiles and the shortening of the tails in each distribution over the 3-, 5-, and 10-year periods highlight that such returns have not typically persisted into the future.

In conclusion, the short-term risk that any individual investor in an active fund could experience returns substantially below the benchmark should be compensated with evidence that active funds typically outperformed over the long term. In the SPIVA Europe Mid-Year 2020 Scorecard, 87% of European equity funds underperformed the S&P Europe 350® over the 10-year period ending June 30, 2020. Therefore, without such evidence, the risk of supernormal fund returns is arguably unrewarded and, until the recent events, may have been largely unexposed.

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

Dissecting Performance Characteristics of Growth Factors in Australian Small-Cap Equities

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Arpit Gupta

Senior Analyst, Global Research & Design

S&P Dow Jones Indices

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In our previous blog, we suggested growth factors with longer lookback periods may be more effective for constructing growth factor portfolios in Australian small-cap equities. In this blog, we examine the performance cyclicality, factor exposure, risk/return decomposition, and factor correlation for the long-term growth factor portfolios.1

From April 20, 2001, to June 30, 2020, the 12-month price momentum and 3-year sales growth factors showed statistically significant outperformance in up markets, with high outperformance probability (>60%), whereas they tended to underperform during down markets (see Exhibit 1). Together with the high market betas (>1.2), these performance characteristics confirmed the strong pro-cyclical nature of the 12-month price momentum and 3-year sales growth factors in Australian small-cap equities. Additionally, under neutral market conditions, the 12-month price momentum factor witnessed statistically significant outperformance, whereas the 3-year sales growth factor underperformed marginally.

On the contrary, weak performance cyclicality was observed for the 3-year earnings growth factor during the back-tested period. The factor showed modest outperformance in up markets and modest underperformance in down markets, with a return beta close to 1. Notably, the 3-year earnings growth factor showed statistically significant outperformance in neutral markets, with more than 70% outperformance probability.

In addition, the 3-year earnings growth factor showed a lower correlation (<0.20) with the 12-month price momentum and 3-year sales growth factors (see Exhibit 2). This differentiated performance across market cycles and low correlation with each other may serve as a basis to construct a composite growth factor portfolio combining the three examined factors.

All the three growth portfolios had high positive active exposure to their targeted factors. The 3-year sales growth and 3-year earnings growth portfolios had the highest exposure to the growth factor, whereas the 12-month price momentum portfolio had the highest active exposure to the mid-term momentum factor. The mid-term momentum factor contributed most to the excess return for the 3-year sales growth and 12-month momentum portfolios, while the profitability factor contributed the highest excess returns for the 3-year earnings growth portfolio (see Exhibit 3).

Unintended factor exposure was also observed among the growth portfolios; most notably, 12-month price momentum and 3-year sales growth portfolios had strong negative active exposure to the dividend yield factor, which was what dragged the performance of both these portfolios most significantly. These portfolios also had higher active exposure to volatility and market sensitivity (i.e., high return volatility and high beta, as observed in Exhibit 1). Higher volatility exposure had negatively affected the returns of the 12-month price momentum and 3-year sales growth portfolios.

In summary, the 12-month price momentum, 3-year sales growth, and 3-year earnings growth factors exhibited distinct performance cyclicality and unique factor exposure in the Australian small-cap equity market. The 12-month price momentum and 3-year sales growth factors showed pro-cyclical characteristics, whereas the 3-year earnings growth factor was much less cyclical. The unique industry factor exposure and style exposure help explain the performance differentials and excess return drivers of these portfolios over the long term.

1 12-month price momentum, 3-year earnings growth, and 3-year sales growth based on the S&P/ASX Small Ordinaries were studied for this analysis.

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