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Opportunity Does Not Equal Attainment

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

Opportunity Does Not Equal Attainment

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Anu Ganti

Senior Director, Index Investment Strategy

S&P Dow Jones Indices

We’ve previously argued that most managers should prefer above-average correlation, because the incremental volatility a manager accepts to pursue an active strategy will be lower when correlations are high. In addition, active managers should prefer above-average dispersion, because stock selection skill is worth more when dispersion is high. Both correlation and dispersion rose in 2020. Despite these relatively auspicious conditions, most active managers still failed to outperform. Why?

The top half of Exhibit 1 illustrates how the required incremental return for large-cap active managers declined in 2020, as correlations rose. In order to understand how difficult it is to earn the incremental return, we can divide the required incremental return by dispersion, as shown in the bottom half of Exhibit 1. The decline in required incremental return below its long-run average suggests that conditions in 2020 were more favorable (or less unfavorable) than usual for active managers.

We see similar results in Exhibit 2 for smaller-cap active managers, as the required dispersion units for the S&P MidCap 400® and S&P SmallCap 600® declined below their historical average as well, signaling a relatively easier environment for active management.

However, our U.S. SPIVA results in Exhibit 3 show that most large-cap funds still underperformed in 2020, although by a bit less compared to their 2019 results. Most smaller-cap funds outperformed, but surprisingly they had done even better in 2019, when conditions for active were more challenging.

Most active managers did not take advantage of 2020’s relatively more favorable environment for stock selection. Higher dispersion, or lower required dispersion units, only help active managers if they have genuine stock selection skill. For other managers, high dispersion might mean larger performance shortfalls. The misalignment between the promising prospects for active management in 2020 and their subsequent performance remind us that true skill is rare and larger active opportunities do not automatically translate into actual outperformance. 

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

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.