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Happy Birthday to Low Vol and High Beta!

A Quiet End to a Strong Quarter for Commodities

Opportunity Does Not Equal Attainment

Concerned about Inflation? Here’s a Tip

The Shift to Passive in India

Happy Birthday to Low Vol and High Beta!

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Fei Mei Chan

Director, Index Investment Strategy

S&P Dow Jones Indices

On April 4, 2011, S&P DJI launched two strategy indices, the S&P 500® Low Volatility Index and the S&P 500 High Beta Index. Ten years of live history let us compare how the two indices actually performed versus their pre-launch back-tests.

Many investors take back-tested history with an understandable grain of salt. But even live history can be deceptive if it doesn’t encompass market environments that reflect the full spectrum of reality. All strategies should be tested through different market environments, particularly strategies like low volatility and high beta that explicitly seek to provide a particular pattern of relative returns. Low volatility strategies seek to attenuate, and high beta strategies to amplify, the performance of the overall market. The behavior of both is therefore highly dependent on the market’s returns.

In the back-tested period from 1991 through March 2011, Low Volatility outperformed the benchmark S&P 500 with lower risk, while High Beta underperformed with higher risk. In the live period, Low Volatility underperformed while maintaining its goal of lowering volatility. High Beta’s live relative performance and risk were both comparable to those of the back-tested period.

Does Low Vol’s live underperformance mean that the index is somehow “broken” or that the back-test was not trustworthy? It’s important to remember that Low Vol’s out-or underperformance is highly dependent on the return of the benchmark S&P 500. The back-tested period included two bear markets: the bursting of the technology bubble and the financial crisis of 2008. With the exception of some small hiccups, the years in the live period, even including a pandemic, were mostly good (if not great) years.

In good markets, a low volatility strategy should not be expected to outperform. Low Vol’s major outperformance comes in years like 2000-2002 and 2008, which, thankfully for us, have not recurred since 2011.

So, did the two indices do what they were designed to do? For that, we look to their performance relative to the market. Exhibit 2 shows the monthly performance differentials of Low Vol and High Beta based on the performance of the S&P 500. Their behaviors have exhibited the same pattern both in the back-tested and the live period. We sometimes compare our indices to children; these two, at least, have been well behaved. Happy birthday.

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

A Quiet End to a Strong Quarter for Commodities

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Fiona Boal

Head of Commodities and Real Assets

S&P Dow Jones Indices

The S&P GSCI will commemorate its 30th anniversary in April 2021 following one of the better quarterly performances in its history. Despite giving up some of its recent gains in March, the S&P GSCI rose 13.5% in Q1 2021. A robust, if uneven, post-pandemic recovery in economic activity, ongoing supply dislocations, and the global push toward decarbonization have combined to point a spotlight on the commodities market.

Across the petroleum complex, March was a month of price consolidation, but the S&P GSCI Petroleum still managed to end the quarter up 22.6%. In some regions, demand concerns have re-emerged, and market participants will be eagerly awaiting the OPEC+ decision on April 1 regarding production. OPEC+ has reduced output by approximately 7 million barrels per day (bpd) to support prices and reduce the oversupply seen since the start of the COVID-19 pandemic. In addition, Saudi Arabia has made an extra 1 million bpd voluntary cut.

Among the industrial metals, nickel cooled off in March after a hot start to the year. The S&P GSCI Nickel dropped 13.6% for the month, pulling YTD performance into slightly negative territory for the metal—mostly associated with electric vehicles. Most of the weakness came at the beginning of the month, when the world’s top stainless steel producer in China announced a deal in Indonesia, easing supply shortage concerns for the metal. While most industrial-focused metals were lackluster in March, despite positive economic data still showing signs that the global economic recovery continued, the S&P GSC Industrial Metals gained 9.0% YTD.

The first quarter of 2021 was one the S&P GSCI Precious Metals would rather forget, falling 9.5%. The S&P GSCI Precious Metals dropped again in March, following renewed strength in the U.S. dollar and continued market appetite for risk assets. One positive in the space came from the S&P GSCI Palladium, which rose 13.2% in March after a dismal start to the year.

Corn ended the quarter at the highest level since June 2013; the S&P GSCI Corn was up 3.1% for the month and 16.9% for the quarter. On the final day of the quarter, the U. S. Department of Agriculture (USDA) released its annual survey of planting intentions, which suggested U.S. farmers would plant significantly fewer corn and soybeans acres than expected. Considering the already strong demand from domestic and international processors, the smaller-than-expected planting of those two main cash crops in the U.S. has heightened concerns regarding global food and animal feed supplies. In the softs market, the S&P GSCI Sugar gave up all of its YTD gains in March, falling 10.2% over the month. Weak demand, particularly in Europe, and a stronger-than-expected finish to the harvest in Thailand have reportedly eased concern about nearby sugar supply tightness.

Once again, the livestock sector was dominated by an ongoing rally in lean hogs; the S&P GSCI Lean Hogs rose 10.4% in March and 27.4% for the quarter. Lean hog prices drew support from the USDA’s March 25, 2021, quarterly hog report, which showed a smaller-than-expected U.S. hog herd.

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

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.