Indexology^® Blog

Retirement investors faced numerous investment headwinds in 2020. In addition to heightened volatility in the stock market, they had to cope with falling interest rates on both regular and inflation-indexed bonds. Real interest rates, interest rates that have been adjusted to remove the effects of inflation, are especially relevant for retirement investors because lower real interest rates reduce the inflation-adjusted income a given account balance can support.

For instance, if the 10-year yield on Treasury Inflation-Protected Securities (TIPS) is 1%, an investment of $0.91 today would be needed to fund a dollar of consumption in 10 years.¹ If the same yield was 2% instead, an investment of $0.82 would suffice. When real interest rates increase, future consumption becomes cheaper. Conversely, when real interest rates decrease, as they did in 2020, future consumption is more expensive to fund, and a fixed balance translates into a lower standard of living.

The S&P Shift to Retirement Income and Decumulation (STRIDE) Indices seek to measure the hypothetical ‘Cost of Retirement Income”. This measure is calculated by taking the present value of a hypothetical inflation-adjusted stream of cash flows, equal to USD 1 per year, starting at various retirement dates and ending 25 years later.² Based on this approach, Exhibit 1 shows how much theoretical real retirement income a $1 million balance could have sustained in 2020.  As a reference point, if real yields were zero at all maturities, the balance would support $40,000 ($1M / 25) in yearly consumption.

At the beginning of the year, TIPS yields for longer maturities were positive, and the balance would have generated around $42,000 in theoretical yearly income. Yields then decreased sharply: for instance, the 10-year TIPS yield stood at -1.1% at the end of 2020. At this point, the same balance of $1 million would have purchased $36,500 in yearly income, a 13% decrease. Managing this source of risk is crucial for retirement investing: as the numbers show, a fixed account balance does not necessarily correspond to a stable standard of living, an important objective for many retirees.

Fortunately, the S&P STRIDE indices measure an income-focused asset allocation that may help manage interest rate risk. Part 2 of this blog will show how the S&P STRIDE Indices fared under challenging conditions in 2020 (spoiler: they performed well).

¹ Calculation based on a zero-coupon bond held to maturity.

² A previous Indexology blog post has additional details (link).

Investments involve risks. The investment return and principal value of an investment may fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original value. Past performance is not a guarantee of future results. There is no guarantee strategies will be successful.

The S&P STRIDE Index Series was developed in collaboration with Dimensional Fund Advisors LP (“Dimensional”), an investment advisor with the U.S. Securities and Exchange Commission. Dimensional Fund Advisors LP receives compensation from S&P Dow Jones Indices in connection with licensing right to the S&P STRIDE Indices.

Plagued by the novel coronavirus pandemic and election uncertainty, 2020 was a year that many are happy to forget. Nonetheless, the S&P 500^® finished strong, up 12.15% for the fourth quarter and 18.40% for the year, driven largely by newly developed vaccines and aggressive economic stimulus measures. In the fourth quarter, yields on the U.S. 10-Year Treasury Bond rose to 0.92%, and in commodities, the S&P GSCI posted a gain of 14.49%, finishing the year down 23.72%.

The S&P Risk Parity Indices built on strong performance in the second and third quarters, reaching new highs in the fourth quarter (see Exhibit 1). The S&P Risk Parity Index – 10% Target Volatility posted a double-digit gain in the fourth quarter, ending the year up 11.48%.

Remarkably, the full-year performance of the S&P Risk Parity Indices significantly exceeded that of the HFR Risk Parity Indices, which represent the weighted-average performance of the universe of active fund managers employing an equal-risk-contribution approach in their portfolio construction.

While the S&P Risk Parity Index – 10% Target Volatility slightly underperformed the HFR Risk Parity Vol 10 Index in the first quarter, it outperformed in the subsequent quarters and finished the year 7.43 percentage points higher than the manager composite index (see Exhibit 2).

The S&P Risk Parity Indices comprise three asset class sub-components: equities, fixed income, and commodities. Let’s analyze the individual asset class performance contribution for the S&P Risk Parity Index – 10% Target Volatility (using excess returns).

The positive performance in the Q4 2020 was driven by commodities and equities, up 5.3% and 5.1%, respectively (see Exhibit 3). For the full year, the performance was driven by equities and fixed income, which finished up 3.8% and 7.6%, respectively.

While 2020 ended up being a strong year for equities, it’s possible that some of the concerns from last year will carry over to 2021. Market participants will have to remain vigilant and make prudent investment choices, and the S&P Risk Parity Indices may be able to help by offering diversification.

Recent headlines have reflected the extraordinary behavior of GameStop Corp.; the company’s stock rose from $18.84 at year-end 2020 to $325 at the close on Jan. 29, 2021, then declined to $90 in the first two trading days of February. At year-end, GameStop was the 314^th largest stock in the S&P SmallCap 600^®. By the end of January it had risen to #1. GameStop had been heavily shorted by hedge funds, and its rise was partly fueled by retail traders hoping to profit from a short squeeze.

Even a casual reader of our SPIVA reports will realize that most active managers underperform most of the time. One reason for this is that there is no natural source of outperformance, or “alpha.” The outperformers’ positive alpha depends entirely on the underperformers’ negative alpha. If the “game” of investment management is played between professional investors and what I affectionately call “undiversified amateurs,” we might expect the professionals to win more often than they lose, given their advantages in fundamental analysis, data access, and trade execution. These advantages might even be enough to allow most professionals to beat the market as a whole; in the 1950s and 1960s, this was often the case in the U.S. asset management business.

By the end of the 1960s, however, the tides had shifted. More and more assets were managed professionally, so that professionals were increasingly competing against each other, not against amateurs. When professionals become dominant, the amateurs who remain don’t generate enough negative alpha for the majority of professionals to outperform consistently. That, among other reasons, is why indexing started in the early 1970s—not a decade sooner or a decade later.

Which is not to say that amateurs are irrelevant. If the relative demise of amateurs helped fuel the rise of indexing, might their resurgence have the opposite effect? And what does the action in GameStop mean for market efficiency? I think the answer to these questions is “no” and “not much.” Consider:

• Despite its 1,625% total return in January, GameStop remains a relatively small company. Its total market capitalization at January’s close was $21.2 billion, which is less than 1% of the market cap of Apple Inc., for the moment the largest stock in the S&P 500^®.
• If GameStop were a member of the S&P 500, its end-of-January ranking would have been #297.
• It may be the case that retail demand can push GameStop up. Without continued demand, however, it won’t stay up, which may be the lesson of the first two days of February.

GameStop has been an interesting phenomenon among small caps, but without great significance for the market as a whole. Within its limits, the stock reminds me of Dr. Johnson’s characterization of Lord Chesterfield: “This man I thought had been a Lord among wits; but, I find, he is only a wit among Lords.”

How are mainstream, exclusion-based approaches to sustainability helping market participants align values and investment objectives? S&P DJI’s Mona Naqvi and iShare’s Sarah Kjellberg explore the design and range of potential applications for the S&P Sustainability Screened Indices.

The year 2021 started with a continuous sell-off in the U.S. Treasury bond market. Starting on the second trading day of the year, yield on the 10-year U.S. Treasury Bond rose for five consecutive trading days by 23 bps until Jan. 12, 2021, when strong auction results for the 10-year note pulled the yield back from its high. In the second half of January, Treasuries’ yield continued to trade lower before it ticked up by the end of the month and found itself in a new range safely above 1%. The yield uptick happened toward the end of the month amid the comments of possible further ECB rate cuts, reassurance of no bond taper for “some time” by the U.S. Fed chairman, and equity market volatility.

From Aug. 4, 2020, to the end of January 2021, the 10-year U.S. Treasury yield rose 56 bps, accompanied by a steadily rising breakeven inflation rate and steepening yield curve. The 10-Year Breakeven Inflation Rate rose by 53 bps over the same period. (This rate reflects the market’s inflation expectation and is calculated as the yield difference between the 10-year U.S. treasury note and Treasury Inflation-Protected Securities [TIPS]). Real yields on TIPS across the curve are trading in negative territory. On Jan. 21, the 10-year TIPS new-issuance auction drew yield at -0.987%, only 13 bps higher than Jan. 4’s record low. The 2s10s yield curve steepened by 56 bps since last August, to the steepest level since 2018.

The Breakeven Inflation Rate rebounded strongly from the pandemic-induced low in March 2020. However, to put it into historical context, the 10-Year Breakeven Inflation, at 2.10% as of the end of January, is 9 bps above the 20-year average and 17 bps above the 10-year average. In comparison, economists are forecasting 2.1% for 2021 inflation, according to a January survey conducted by Bloomberg. The latest inflation data, released on Jan. 13, showed a small increase, to 1.4% year-over-year.

Possible factors contributing to higher market-based inflation may be a weak U.S. dollar, market expectation of more economic stimulus, hopes of an improved economic outlook following the start of the COVID-19 vaccine rollout, and the Fed’s signal of willingness to keep inflation running higher than the 2% target before hiking rates. On the other hand, inflation skeptics may point to the slack in the labor market and in the output gap. It remains to be seen if loose monetary policy and expansive fiscal spending will push inflation up or not, but inflation concerns will likely remain in investors’ minds in 2021.