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Concerned about Inflation? Here’s a Tip

The Shift to Passive in India

Exploring Equal Weight’s Impact on Risk/Return

Risk-Adjusted SPIVA Year-End 2020 Scorecard: No Evidence to Support Superior Risk Management Skills of Active Managers

Special Purpose Acquisition Companies (SPACs) – Part II

Concerned about Inflation? Here’s a Tip

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Jim Wiederhold

Associate Director, Commodities and Real Assets

S&P Dow Jones Indices

The newly launched S&P GSCI (U.S. 10-Year TIPS) TR was designed with inflation protection in mind. This index takes the renowned broad commodity market benchmark, the S&P GSCI, and aims to add boosted return potential from an exposure to on-the-run U.S. 10-Year Treasury Inflation-Protected Securities (TIPS). Normally, the S&P GSCI TR includes the collateral yield from the U.S. 3-Month T-Bill rate. The S&P GSCI (U.S. 10-Year TIPS) TR exchanges that T-Bill rate for the U.S. 10-Year TIPS, represented by the S&P U.S. TIPS 10-Year Index. If we are entering a period of high inflation, collateralizing commodity exposure with TIPS may be attractive to some market participants. Historically, real assets, including commodities, real estate, infrastructure, and inflation-linked bonds have exhibited a positive correlation to inflation. A strategy that combines commodities and inflation-linked bonds may help hedge inflation risk and maintain the purchasing power of the investment.

Most of the return from this new index comes from the S&P GSCI, which is the most widely recognized broad commodity market benchmark available. Commodities tend to perform well in high inflation environments as opposed to low inflation environments, like those seen during the 2010s. With a combination of highly accommodative central banks since the Global Financial Crisis, globalization, productivity improvements advanced by technology, and a global push to lower costs everywhere, commodities lagged other asset classes. Many commodities that flirted with record low prices in the wake of the initial COVID-19 lockdowns have recovered strongly over the past 12 months, benefiting from a rebound in demand, expansive fiscal spending programs, and ongoing supply disruptions. Prior periods of commodity price strength have tended to coincide with high and rising (usually unexpected) inflation.

The S&P GSCI (U.S. 10-Year TIPS) TR may offer market participants the opportunity to hedge against the risks of inflation. Historically, commodities outperformed during inflationary times. During prior periods of extreme volatility, like the COVID-19 lockdown drop and Global Financial Crisis, market participants expected the worst and reset their inflation expectations lower. Exhibit 3 shows what happened to inflation expectations during shocks to the markets and how quickly they recovered.

Check out https://www.spglobal.com/spdji/ for more information and be sure to tune in to our new content coming in April as we celebrate the 30th anniversary of the S&P GSCI.

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

The Shift to Passive in India

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Tyler Carter

Associate Director, Global ETF Strategy

S&P Dow Jones Indices

In 2020, the Indian ETF market continued to expand, finishing the year with ~USD 37 billion in assets spread across 99 listings. This represents a year-over-year increase of USD 23.3 billion, or 171%, placing India as the ETF market in the Asia-Pacific region with the highest growth on a percentage basis in 2020.1 Within the region, India represents the seventh-largest ETF ecosystem and the fourth-largest emerging market ETF ecosystem.

In a broader context, the Indian ETF market is over twice the size of the entire Latin American ETF market on an asset basis. It is larger than each individual country in the Middle East and Africa, including developed countries such as Israel. When looking to Europe, India would be the largest emerging market country and ahead of multiple developed markets such as Italy and the Netherlands, which have fairly robust ecosystems.

There are certainly several factors that appear to have driven this growth for the market, which reached its 20th anniversary this year. The most notable comes down to the relative outperformance of passive versus active funds. According to S&P DJI’s SPIVA® India Mid-Year 2020 Scorecard, the S&P BSE 100 outperformed 83.08% of active funds over the three-year period ending June 2020. So the most-tracked index on the Indian ETF market outperformed over 8 out of 10 active funds. This helps explain the underlying force driving flows into ETFs across global markets, which have seen passive overtake active in terms of percentage of total assets.

Herein lies a major headwind for the ETF industry in India. Active funds typically have fees that are higher than passively managed ETFs, which disincentivizes institutional ETF use. Equity fund fees average around 200 bps, while the fees associated with ETFs average around 5 bps.2 Investor education and Indian investor increased demand for ETFs may compel active fund managers to adjust their fee structure. We have already seen this shift in the U.S. and other markets, and there is no structural reason it could not occur within the Indian market as well.

Even with institutional headwinds, ETFs are making inroads in India. ETFs more than doubled their market share of the Indian mutual fund industry in 2020, moving from 4% of mutual fund assets in 2019 to 9% through year-end 2020.1,5 This growth comes on the heels of regulatory change that could affect the way investors view ETFs. In 2018, the Securities and Exchange Board of India (SEBI) changed benchmarking rules for active equity funds to more accurately depict active fund performance,3 and in 2013, it imposed standards for fee-based advisors that would require them to exercise a greater duty of care for investors when compared to institutional distributors.4 Both these changes have set the stage for the possibility of continued long-term growth into low-cost passive funds in the Indian market.

 

1 ETFGI, December 2020

2 https://cfasocietyindia.org/wp-content/uploads/Media-Uploads-Advocacy/A-Report-on-the-Indian-Exchange-Traded-Funds-ETF-Industry-by-CFA-Society-India.pdf

3 https://www.sebi.gov.in/legal/circulars/jan-2018/benchmarking-of-scheme-s-performance-to-total-return-index_37273.html

4 https://www.sebi.gov.in/sebi_data/attachdocs/1358779330956.pdf

5 https://www.outlookindia.com/outlookmoney/mutual-funds/mutual-fund-aum-rises-17-in-2020-5824

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

Exploring Equal Weight’s Impact on Risk/Return

What are the potential risk/return benefits of the S&P 500 Equal Weight Index? S&P DJI’s Hamish Preston and Tim Edwards explore what’s driving the mega-cap trend, multi-decade highs in S&P 500 concentration, and potential applications for the S&P 500 EWI.

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

Risk-Adjusted SPIVA Year-End 2020 Scorecard: No Evidence to Support Superior Risk Management Skills of Active Managers

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Berlinda Liu

Director, Global Research & Design

S&P Dow Jones Indices

Modern Portfolio Theory tells us that higher returns tend to be associated with higher risk. Active managers tend to boast about their risk management skills and claim that they can generate higher returns than passive funds on a risk-adjusted basis. The Risk-Adjusted SPIVA® Scorecard assesses the risk-adjusted returns of actively managed funds against their benchmarks on both a net-of-fees and gross-of-fees basis. Volatility, calculated as the standard deviation of monthly returns, is used as a measure of risk, and performance is evaluated by comparing return/volatility ratios.

The Risk-Adjusted SPIVA Year-End 2020 Scorecard shows that the significant level of volatility and positive returns of the broad U.S. equity market in 2020 did little to help the case for active managers’ performance. After adjusting for risk, most actively managed domestic funds across market-cap segments underperformed their benchmarks on a net-of-fees basis over mid- and long-term investment horizons. Even on a gross-of-fees basis, the number of outperforming segments declined over time; small-cap value and real estate funds were the only two categories that outperformed their benchmarks over the 20-year period.

For comparison, in Exhibit 2, we listed the performance statistics of active equity funds relative to their benchmarks, both on an absolute return basis (as presented in the SPIVA U.S. Year-End 2020 Scorecard) and on a risk-adjusted basis. Over the 20-year period, fewer than 15% of actively managed funds were able to outperform across any of the three categories, whether the returns were adjusted for risk or not.

Exhibit 3 further confirms that, even within each capitalization segment, little evidence was found to support the theory that higher returns are associated with higher risk. Plotting the annualized returns and annualized volatility of individual funds in scatter plots, we found weak correlations and no trend between these two variables, indicating the difficulty to generalize active managers’ risk management skills as a group. The yellow dots in Exhibit 3 represent the annualized return and volatility of the three benchmarks. Clearly, the benchmark produced higher returns than most active funds at the same level of volatility.

Conclusion

Although active managers claim that their risk management skills are superior to passive investment strategies, their claim does not stand the test of historical statistics. The Risk-Adjusted SPIVA Year-End 2020 Scorecard shows that our SPIVA Scorecard results also hold on risk-adjusted basis. Most active funds lagged their benchmarks in the long term, and we found little evidence to support the assumption that higher risks were rewarded by higher returns.

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

Special Purpose Acquisition Companies (SPACs) – Part II

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Jason Ye

Associate Director, Strategy Indices

S&P Dow Jones Indices

In the previous blog, we introduced SPACs and discussed market trends that emerged given SPACs’ popularity. In this blog, we will discuss SPACs’ lifecycle, as well as the benefits and risks of investing in SPACs.

SPAC Life Cycle

There are three stages in a typical SPAC life cycle.

1. A SPAC’s IPO

When SPAC sponsors form a SPAC, they are typically given 20% of the post-IPO shares for a nominal investment amount. The SPAC then goes through the IPO process. In a typical SPAC structure, the SPAC raises capital by issuing units consisting of one share and one-half or one-third of a warrant. On NASDAQ for example, the shares are generally priced at USD 10 and the warrants are typically struck 15% out of the money (USD 11.50) with a five-year term and a USD 18 forced exercise.1

The capital raised is held in a trust account. The common stock and the warrant typically begin to trade separately, starting on the 52nd day following the IPO.2 Thus, a SPAC could have multiple instruments listed simultaneously, including unit, common stock, and warrant.

2. Seeking a Target

After the IPO, the sponsors will start to search for an acquisition target and finalize the transaction terms once the target is found. NASDAQ requires that the transaction must be valued at 80% or more of the funds held in the trust.3 Typically, the sponsors have 18-24 months to find a target.4

3. De-SPAC

Once the acquisition target is found, depending on the SPAC’s prospectus, shareholders may need to vote on the transaction, or they will receive redemption notices if they choose to receive a pro-rata amount from the trust account and walk away. If the acquisition is approved by shareholders, the SPAC merges with the target company and will often undergo an identifier change to reflect the name of the target business. Otherwise, the sponsor will resume searching for another target. If the sponsor fails to find a suitable target within the pre-defined timeframe, the SPAC will be liquidated, and the investors will receive their capital back from the trust account. This process is detailed in Exhibit 1.

Based on a SPAC’s life cycle, we can split a SPAC’s status into five categories: active, announced merger, effected merger, cancelled merger, and liquidated. Currently, most SPACs in the U.S. are actively looking for the acquisition target (see Exhibit 2).

Benefits and Risks of SPAC Investing

Market participants can gain several benefits through investing in a SPAC, compared with investing in private equity.

  1. Institutional access: SPACs offer access to investment in acquisitions that are typically otherwise restricted to large institutions through private equity. With SPACs, retail investors can invest with the SPAC sponsors who usually have investment and industry expertise. Unlike private equity, investors do not have to pay management fees to SPAC sponsors.
  2. Downside protection: The capital raised through an IPO is held in a trust account pending approval of the acquisition, and a redemption option is available for investors. The trust account provides a minimum liquidation value per share, which serves as downside risk protection.

However, investors should also be aware of the risks involved when investing in SPACs.

  1. It’s a blank check company: A SPAC possesses no assets other than the sponsors’ professed “know-how.” The investor is betting on the sponsors to make a wise acquisition. Presumably, an investor would not invest in a SPAC without confidence in SPAC sponsors and their prior track record of investment success.
  2. Incentive misalignment – time pressure: The 24-month timeline imposed on the sponsors to acquire a target puts SPAC sponsors under significant pressure. Unlike investors, SPAC sponsors are not entitled to receive any interest back if the acquisition does not occur. This structure creates an almost “do-or-die” situation for sponsors. Thus, SPAC sponsors have every incentive to acquire a target within the requisite period.
  3. Incentive misalignment – valuation: Since the target company must comprise over 80% of the trust account asset, the SPAC’s sponsors may overpay for the target company to get the deal done.

Summary

A typical SPAC goes through three stages during its life cycle: IPO, seeking a target and business combination (de-SPAC). When investing in SPACs, investors gain access to private equity-like opportunities with downside protection. However, investors should also be aware that SPACs possess no assets, and sponsors’ interests may not align with those of the investors. In the next blog, we will analyze SPACs’ liquidity and historical performance.

 

Reference:
Lewellen, S. (2009). SPACs as an Asset Class. Available at SSRN 1284999 http://ssrn.com/abstract=1284999

1 The specific terms of listing price and warrant depend on the individual IPO prospectus.

2 https://www.nasdaq.com/articles/your-guide-to-analyzing-spac-investments-2021-01-31/

3 https://www.sec.gov/rules/sro/nasdaq/2020/34-90245.pdf.

4 NASDAQ allows 36 months for SPACs to complete business combination; SPACs are also allowed to extend this deadline per shareholders’ approval.

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