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Decrement Indices Explained

Tesla: Not an Automatic Addition to the S&P 500 ESG Index

So Different Yet So Alike…

Core Considerations: Why Liquidity Matters


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Craig Lazzara

Former Managing Director, Index Investment Strategy

S&P Dow Jones Indices

Lyndon Baines Johnson became President of the United States at a moment of national trauma, and left office at a time of tremendous political division. Despite a landslide electoral victory in 1964 and notable legislative achievements, his was not a happy presidency. LBJ observed, in fact, that “being President is like being a jackass in a hailstorm. There’s nothing to do but to stand there and take it.”

Regardless of whether it’s true of the presidency, Johnson’s analogy was clearly applicable to equity investors in 2020. Consider the vicissitudes of the S&P 500®:

  • The year got off to a good start, as the market rose by 5.1% until peaking on February 19.
  • Then began one of the most precipitous declines in market history. The S&P 500 fell by -33.8% between February 19 and March 23. (In the global financial crisis of 2007-09, the comparable decline required a full year.) When the market closed on March 23, the S&P 500’s year-to-date total return stood at -30.4%.
  • In an extraordinary rebound, the S&P 500 rallied by 61.4% between March 23 and September 2.
  • This was followed by a -9.5% decline until September 23, a 9.3% gain through October 12, and a -7.4% decline through October 30.
  • The year ended with a gain of 15.2% in November and December.

Between March 23 and year-end, in other words, the S&P 500 rose 70%. What did an investor have to do to benefit from this remarkable turnabout in the equity market?

Nothing. We’ve argued before that sometimes successful portfolio management requires holding positions when one’s natural instinct is to sell, and 2020 provided an emphatic demonstration of that principle.

Although last year’s recovery was unusually large, Exhibit 1 shows that it was by no means unique. Over the last 30 years, the annual total return of the S&P 500 has averaged 12.2%. But it’s rare for the market to rise without a pause; in 27 of those 30 years, at some point during the year the S&P 500 has had a negative total return. Across all 30 years, the total return at the year’s low point was -9.1%. The average recovery from the annual low has been 23.8%.

Even in extreme declines, standing firm can pay off. There have been ten years (including 2020) when the S&P 500’s peak-to-trough decline exceeded 15%; in half of them, the market finished in positive territory. A year later, the gain from the bottom averaged 38%.

Market history tells us that selling can be most damaging precisely when it’s most tempting. The key to success in 2020 was resisting the urge to panic when panic seemed like the most reasonable path. Like Johnson’s proverbial jackass, the only requirement was “to stand there and take it.” Investors who tolerated the downdrafts were well-rewarded by year end.

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

Decrement Indices Explained

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Izzy Wang

Senior Analyst, Factors and Dividends

S&P Dow Jones Indices

Decrement indices have gained popularity as the underlying assets of equity-linked structured products in Europe and Asia. According to SRP, among the 318 products across asset classes in France that matured or autocalled between April 2018 and March 2019, more than 32 were linked to decrement indices.1

One of the reasons behind this recent popularity is today’s low interest rate environment, which makes it challenging for structured product issuers to design attractive products. This triggered a search for a new underlying asset that could deliver cheaper optionality. Decrement indices were designed for this purpose. By eliminating dividend risk, issuers could provide more favorable terms at the structural level, such as higher participation rates and improved capital protection.

It is important to understand that the gain on favorable product terms does not come without cost. Exhibit 1 illustrates some of the tradeoffs for structured products linked to decrement indices compared with conventional indices. To understand the risk for the underlying index, it is worthwhile to look at the construction of decrement indices.

How Do Decrement Indices Work?

A decrement is an overlay applied to equity indices. A decrement index is constructed by deducting a predefined dividend (also known as a synthetic dividend) from a total return index on a daily basis. As total return can also be broken down into price return and realized dividends,2 a parity relation exists between price return and decrement index return with dividends added (see Exhibit 2).

Depending on whether the fixed synthetic dividend (refer to RHS in Exhibit 2) is greater or less than the actual realized dividends received (refer to LHS in Exhibit 2), the decrement index could underperform or outperform the corresponding price return index. To deliver returns similar to those of the price return index, the predefined dividend markdown should be roughly the same as the realized dividends. If the predefined dividend markdown is significantly larger than the average realized dividends, a decrement index could persistently underperform its price return version.

When the market is stable or steadily increasing, decrement indices tend to be more beneficial to investors compared with the price return index. In adverse market conditions, however, it is important to acknowledge that decrement indices may represent a large reduction in returns.

For example, during COVID-19 sell-off, the S&P 500® price return index dropped by 34% from Feb. 9, 2020, to March 23, 2020. For a 20-point decrement index starting from an initial index level of 1000, a 34% drop in the index level meant an increase in the return deduction from 2% to 2.6%.

Fixed Percentage Deduction versus Fixed Point Deduction

Decrement indices use two major methods to deduct the predefined dividends: fixed percentage or fixed points. On a daily basis, the former deducts a fixed percentage of the returns while the latter subtracts fixed index points from the index level.

The logic of using the fixed percentage method is that dividend yield tends to be stable over the long term. During the past 10 years, the trailing 12-month dividend yield for the S&P 500 was relatively stable, around 2%. Therefore, dividend markdowns for fixed percentage decrement indices are often in line with historical long-term dividend yield averages.

On the other hand, a fixed points deduction captures the consistency in dividend amounts in the short term, as companies are inclined to maintain more stable dividend policies compared to their earnings. For fixed points decrements, the effective percentage deduction on the index base date, which is calculated by fixed points divided by initial index level, is usually set to be consistent with the recent realized dividend yield.

These two methods are often close when the market is stable but could display significant differences in the movement of the underlying index level. Specifically, the percentage deduction from total return is constant for fixed percentage decrement indices; and variable for fixed point decrement indices, depending on the market movement direction (see Exhibit 3).

Key Takeaway

The decrement strategy is an index innovation that aims to solve specific challenges presented by structured products—–a low interest rate environment and the need to hedge dividend risk. Despite the simple construction, there are nuances that market participants may want to better understand, such as potential underperformance when deduction is too high and varying deduction methods. For more information on the S&P Decrement Indices, please refer to the “Fee Indices/Decrement Indices” section of the Index Mathematics Methodology document, as well as the S&P Dow Jones Decrement Indices Parameters.

1 SRP, Structured Products Performance Review, France, April 2018 to March 2019. Retrieved from

2 Including dividends reinvestment.

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

Tesla: Not an Automatic Addition to the S&P 500 ESG Index

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Daniel Perrone

Former Director and Head of Operations, ESG Indices

S&P Dow Jones Indices

Since S&P Dow Jones Indices announced that Tesla would be added to the S&P 500® on Dec. 21, 2020, many investors have contacted us asking when this transformative company will become a member of the S&P 500 ESG Index, the sustainable counterpart to the S&P 500. The answer, in brief, is that Tesla will not automatically join the S&P 500 ESG Index upon its addition to the S&P 500. Instead, Tesla will be assessed during the next annual rebalance of the S&P 500 ESG Index, taking place at the end of April 2021. But even then, inclusion into the index is not assured. Whether Tesla becomes an index constituent will be determined by its sustainability performance across many criteria relative to its peers.

Tesla’s ESG Score

The main driver of whether a company is selected to join the S&P 500 ESG Index is its S&P DJI ESG Score. This score is derived from the annual Corporate Sustainability Assessment (CSA), which is administered by SAM, a part of S&P Global. The CSA is a highly granular, industry-specific questionnaire based on financial material ESG metrics. Insights gathered from the CSA form the backbone of the ESG score that is used to select companies added to the S&P 500 ESG Index.

For this current assessment year, Tesla’s S&P DJI ESG Score was 22 out of 100, up 8 points from 2019’s score. This is driven by its ESG Dimension Scores, including an Environmental score of 28 (up 1 point from last year), a Social score of 6 (up 2 points), and a Governance score of 49 (up 21 points). Tesla does not fill out the CSA, so its S&P DJI ESG Score is determined based on research using publicly available information.

Many may be surprised to see such a low overall ESG score (and Environmental score) for Tesla, given its focus on electric vehicles. Specializing in “green” products, however, does not automatically ensure that companies will score well from an overall ESG perspective. The S&P DJI ESG Score is wide ranging in what it encompasses, as it is meant to capture a company’s broad sustainability performance.

In the Environmental dimension, Tesla of course scored well in the area of low carbon strategy, with a nearly perfect score of 99. However, the company scored low in environmental reporting, climate strategy, and environmental policy and management systems, which suppressed the company’s overall Environmental score.1 Tesla also scored especially low on social metrics across the board, which include human capital development, social reporting, and labor practice indicators. Tesla did comparatively well in the Governance realm, especially relative to the prior year.2

The S&P 500 ESG Index Methodology

So, what does this mean for Tesla’s standing in the S&P 500 ESG Index? We won’t know until the upcoming annual rebalance is finalized on the last business day of April 2021. At that time, Tesla will be measured against its peers across many ESG criteria. As mentioned earlier, however, the biggest determinant of the composition of the S&P 500 ESG Index is a company’s S&P DJI ESG Score. But it’s not just a company’s absolute performance that matters; a company also needs to rate well relative to its peers.

The S&P DJI ESG Score is used in two ways in the index methodology. First, the bottom 25% of companies in each GICS® industry group is screened out on a global basis. This prevents a company that is a good ESG performer locally but poor on a global basis from making it into the index. Second, companies are ranked by their ESG score within the S&P 500 and then selected from the top down to get as close as possible to 75% of the industry group’s original market capitalization.

Will Tesla make it through these two key screens and become a member of the S&P 500 ESG Index? Next April, we’ll know. The S&P 500 ESG Index has no early-entry rule that would afford Tesla extra privileges; it will be treated the same as any other company.


The author would like to thank Reid Steadman for his extensive contributions to this blog post.


1 According to the CSA, low carbon strategy (which is a unique criterion to the automobiles industry) is defined as an assessment of strategies implemented by companies to reduce the carbon intensity of their core portfolio, while climate strategy is defined as an assessment of strategies put in place by companies to address the scale of the challenge climate change represents for their industry, and environmental policy and management systems covers management tools implemented by companies in order to improve their environmental performance in a cost-effective way and reduce the risk of incurring fines or penalties for not complying with environmental legislation.

2 To provide some context for Tesla’s scores, the S&P DJI ESG Scores are normalized across global industries and are designed to be read as percentiles. Thus, a score of 22 means that that company had a higher score than 22% of its industry peers globally.

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

So Different Yet So Alike…

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Fei Mei Chan

Former Director, Core Product Management

S&P Dow Jones Indices

To say that the world is different now than it was a year ago would be an astounding understatement. COVID-19 brought about once unimaginable conditions and changes. In the financial realm, market volatility spiked and remains markedly higher across all sectors compared to the beginning of 2020. Yet, observing the market based purely on performance, it would almost seem as if all was normal. The S&P/TSX Composite Index, after March’s blip, is up 6.8% through Dec. 17 and continuing its uptrend heading into the new year.

The changes in latest rebalance of the S&P/TSX Composite Low Volatility Index, effective after the close of trading on Dec. 18, 2020, were predictably small based on the changes in sector volatility in the last three months shown in Exhibit 1. The index shifted 2% of its weight away from Health Care and Information Technology, while shifting the most weight into Utilities and Industrials. There were only three name changes.

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

Core Considerations: Why Liquidity Matters

Learn how the liquidity and interconnectivity of the S&P 500 ecosystem benefits market participants. CME Group’s Tim McCourt and State Street Global Advisors’ Rob Forsyth join S&P DJI’s Craig Lazzara to discuss.


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