Indexology^® Blog

We introduced the S&P Kensho Moonshots Index (the Moonshots index) and its constituent next-generation innovators in our previous blog. An express intent of the index is to identify innovative companies early in their gestation, when the opportunities for rapid growth may be higher. In this blog, we examine how effective the index is at capturing that potential for higher early-stage growth, and how it stacks up against more established innovators, as reflected in market returns.

To identify established innovators, we constructed a comparative portfolio made up of companies drawn from the selection universe used by the Moonshots index, whose market capitalization exceeded the maximum threshold at each rebalance, but whose Early-Stage Innovation score would have qualified for inclusion (Established Innovators—see the methodology document for more info).

The market consistently rewarded the Moonshots index over the Established Innovators on an annualized return basis over one-, three-, and five-year periods (see Exhibit 1). These findings suggest that the market attaches a premium to the early-stage innovators identified by the Moonshots strategy.

Annualized returns can often mask periods of underperformance; however, Exhibit 2 shows how the Moonshots index consistently outperformed on a calendar year basis, with the only exceptions being 2015 and 2018, when the Established Innovators edged ahead.

It is also worth noting that, despite its focus on relatively smaller companies, the Moonshots index and the Established Innovators exhibited similar levels of volatility. The outperformance of the Moonshots index relative to the Established Innovators is therefore not a function of higher risk.

The magnitude of the Moonshots index’s historical outperformance relative to small- and mid-cap benchmarks on an annualized basis (see Exhibit 3) emphasizes how differentiated the index is from its similarly sized peers. In fact, during a time when small- and mid-cap companies generally underperformed their larger brethren, it is of particular interest that the Moonshots strategy is able to outpace both constituencies.

However, a review of calendar year relative performance (see Exhibit 4) suggests a more nuanced picture.

It highlights an important characteristic: accelerating outperformance as emerging exponential innovation gains traction.

Rapid developments in artificial intelligence, robotics and automation, ubiquitous connectivity (Internet of Things) and exponential processing power—together, the catalysts of the Fourth Industrial Revolution—as well as their application in innovations across the global economy, have greatly accelerated over the past few years. The pivot in the Moonshots index’s track record in 2017 from one of moderate underperformance to consistent and significant outperformance is aligned with the increase in investor awareness of these macro dynamics and an acceleration in the adoption of these underlying transformative technologies.

Today’s rapid pace of technological advancement means companies must commit to innovation in order to survive and thrive. The outperformance of the S&P Kensho Moonshots Index versus both established innovators and similarly sized peers suggests that it is successfully capturing the higher growth potential of these emerging leaders, or next-generation innovators.

The author would like to thank John van Moyland, Managing Director, Global Head of S&P Kensho Indices for his contributions to this blog.

In a recent webinar I moderated, Brie Williams of State Street Global Advisors joined me to discuss how environmental, social, and governance (ESG) data and investing are now at an important turning point. We ran out of time to answer all the questions we received, and this post follows “Why Now for ESG?” and answers two questions about how conversations on ESG can change and add value for an advisory or wealth management firm and to its clients.

Question: How does ESG stand out compared to other approaches like impact investing?

Brie Williams, State Street Global Advisors: ESG is more than just a “do-good” mentality. There is a no-compromise approach when it comes to investors’ performance expectations for ESG.

• Industry and academic studies offer empirical evidence for potentially better long-term risk-adjusted returns, lower downside, and improved volatility in ESG strategies.¹
• The increasing number of ESG options reflect the diversity of investor objectives, including avoiding or reducing ESG risk, while seeking a measurable impact, in pursuit of better investment outcomes.
• One-third of investors agree it’s possible to achieve market-rate returns investing in companies based on their social or environmental impact; more Millennials (55%) than Gen X (35%) and Boomers (24%) agree with this.²

 Question: My client hasn’t asked me about ESG.  So why should I bring ESG up?

Brie: Investors’ need for advice in ESG investing is the advisor’s opportunity to add value in a meaningful way.

• Investors are signaling planned increases in allocation. 25% of U.S. investors say they are likely to increase their ESG investment allocation level over the next 24 months. Generationally and globally, 31% of Millennials and 23% of Gen X are more likely.³
• In pursuit of better investment outcomes, advisors are viewed as instrumental: 75% of Millennials indicate it is important that advisors help with ESG—and Gen X isn’t too far behind them, with 63% of this client segment viewing the advisor’s role as key.⁴
• Effective integration of ESG principles into a portfolio begins with a client-focused process—not a product-focused process. Our three-phased framework can help focus the ESG conversation with clients.
  1. Identify a clear entry point (investment objectives, ESG priorities, and market opportunities).
  2. Keep risk in perspective (investment outcome desired, allocation, and integration considerations).
  3. Take the long view (time horizon, intended impact, and defined success measures).

The 2010s were all about laying the groundwork for ESG investing through education and government regulation. The 2020s will be about renewed commitment and putting ESG investing into action, including:

• Better data leading to better investment solutions, as well as continuous improvement of ESG reporting;
• ESG sustainable investing is not just about values, but about managing risks, and to the extent that ESG is linked to long-term returns, it will likely be valuation-driven; and
• Discovery and education with the individual investor to better understand their motivations and support their goals across the various stages of their ESG journey (as learners, adopters, and ultimately, leaders).

¹ The Boston Consulting Group, “Total Societal Impact: A New Lens for Strategy,” Oct. 25, 2017.

² State Street Global Advisors, “Individual Investors 2019 Study: A Global Survey on Consumer Sentiment, Purpose, and Behavior in Wealth Management,” 2019.

³ Ibid.

⁴ Ibid.

S&P DJI’s Tim Edwards explores how financial advisors can use index data, human behavior, and SPIVA® results to inform allocations and better understand assumptions about active fund performance.

Key to evaluating core international equity benchmarks is an understanding of the country exposures offered. Developed and emerging market country classification differences between index providers may lead to notable geographic exposure differences across market segments. One of the most meaningful instances of this involves South Korea, which S&P DJI has classified as a developed market since 2001, while MSCI continues to classify the country as an emerging market.¹

In our latest blog in a series highlighting key features of the global equity benchmark landscape, we explore South Korea’s classification as a developed market and the impact of its inclusion within the MSCI Emerging Market indices.

South Korea’s Fit in the Developed Market Universe

S&P DJI annually conducts a complete review of all countries included in its global equity benchmarks. Similar to other index providers, this process involves an evaluation of markets by various economic and market accessibility criteria. S&P DJI has classified South Korea as a developed market since 2001 because of its high level of economic development, considerable size and liquidity, absence of significant foreign investment restrictions, and GDP per capita alignment with developed economies (see Exhibit 1). Over the years, S&P DJI has confirmed this classification through its annual country classification consultation process, which involves feedback from a wide range of market participants.

Viewed through the lens of company revenues on a geographic basis, the largest South Korean companies overwhelmingly gain revenues from developed economies. In comparison, the largest companies based in less-developed countries gain nearly all their revenues from other emerging economies. Therefore, the inclusion of South Korea in an emerging markets index leads to less underlying economic exposure to typically faster-growing emerging economies. A notable example of this phenomenon is Samsung Electronics, which is based in South Korea and derives approximately 59% of its revenue from developed markets and is the fourth largest position in MSCI Emerging Markets.

Crowding Out Less-Developed Countries   

While excluded from the S&P Emerging LargeMidCap, South Korea represents an outsized weight of 11.9% in MSCI Emerging Markets, potentially crowding out less-developed markets from the benchmark.

Since country exposure is a key driver of the risk and return of emerging market equities, it is imperative to fully understand your benchmark to ensure the exposure is consistent with the expected characteristics of emerging markets.

To learn more about the comprehensive coverage of the S&P Global BMI Index Series, see The S&P Global BMI: Providing Consistent Insights into Global Equity Markets since 1989.

¹ FTSE promoted South Korea’s standing in 2009.

In a recent webinar I moderated, Brie Williams of State Street Global Advisors joined me to discuss how environmental, social, and governance (ESG) data and investing are now at an important turning point. During that webinar, we answered some advisor questions. I encourage you to watch this replay if you missed it. We ran out of time to answer all the questions we received, so I thought it would be worthwhile to bring our discussion to Indexology to “extend our time” and, in that way, answer more questions advisors may have as they evaluate how and in what ways to position ESG investing. In this first post, I have grouped questions on the theme, “Why Now for ESG?” In a follow-up post, I will cover a second, related theme, “How Is the ESG Discussion Changing?”

Q: ESG has been around for a while. What is different now that should command our attention?

Brie Williams, State Street Global Advisors: When it comes to ESG investing, the world is changing. Investor engagement is growing while data and analytics that track the performance of these strategies are evolving. As a result, ESG adoption is accelerating.

• Globally, the percentage of retail and institutional investors that apply ESG principles to at least a quarter of their portfolios jumped from 48% in 2017 to 75% in 2019.¹
• Specific to scoring data, the more ESG data providers are investing in developing ESG scoring solutions, the more companies will prioritize reporting and disclosure. After all, we can only focus on financial materiality so distinctly because increased reporting in non-traditional areas has already been in motion.

Q: We always hear about incredible amounts of money tracking ESG, but is that all in other countries, or solely institutional clients? What do you see going on with ESG ETFs and mutual funds?

Brie: ESG is an evolving space and relatively small from an asset base and product offer space; however, development is becoming more dynamic and diverse, with new products and new issuers as well as conversions of existing products to ESG.

• Most of the assets lie in equity, where flows are favoring broad ESG over thematic.
• The industry is trending toward lower-cost solutions, with over 50% of U.S. ESG ETFs launched in the past two years having a net expense ratio under 20 bps.
• ETFs are helping to democratize access to ESG, enabling investors large and small to better realize their investment objectives.

And the cash flow story behind the ESG superhighway is dynamic.

• Sustainable funds attracted an estimated USD 45.7 billion in net flows globally during the first quarter of 2020, even while the overall fund universe suffered USD 384.7 billion in outflows as markets plunged in response to the pandemic.²
• We project a nearly eight-fold increase in global ESG ETF and indexed mutual fund assets, from USD 170 billion as of May 31, 2020, to more than USD 1.3 trillion by 2030.³

Q: Is ESG an idea with staying power, or is it a “flavor of the year” in the financial media and product marketing space?

Brie: Three trends are positioning ESG to transform from a check-the-box portfolio component to a significant component of a portfolio.

1. The great reset in a turbulent 2020, with “S” and “G” issues at the forefront

The management of “E” and “S” risks will likely emerge as the new standard of comprehensive corporate governance—and underscore how non-financial E, S, and G factors may affect long-term valuation.

2. Investors are reshaping what’s next. Industry transformation is under way, helping investors to:
   • Incorporate ESG factors for sustainable performance;
   • Rely on better data to make better decisions;
   • Gain ESG exposure with cost-effective ETFs; and
   • Customize portfolios with ESG funds.
3. Changing investment demographics

Large-scale wealth transfers—nearly USD 15.4 trillion in global wealth transferred by 2030⁴—and a greater emphasis on living according to values have encouraged ESG adoption. Those changes will presumably reverberate and be magnified through increased government regulation and institutional investments.

¹ BPN Paribas, “The ESG Global Survey 2019,” 2019.

² Morningstar, March 31, 2020.

³ State Street Global Advisors, June 2020, based on Morningstar data as of May 31, 2020.

⁴ Wealth-X, “A Generational Shift: Family Wealth Transfer Report 2019,” June 2019.