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Face-to-Face with the Metaverse

Beyond Bitcoin: Why Digital Assets Need a Classification System

Holding Period Returns

How Does the S&P Europe 350 ESG Index Work?

India's ETF Market: Sustainability and Innovation

Face-to-Face with the Metaverse

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Srineel Jalagani

Senior Director, Thematic Indices

S&P Dow Jones Indices

Metaverse on the Runway to Reality

S&P DJI recently launched the S&P Kensho Metaverse Index, which is designed to track the growing group of technologies under the metaverse banner. The origin story of the metaverse can be traced back to a science fiction novel in the early ‘90s. Since then, it has seen many reincarnations under different names.1 Nonetheless, one core idea has remained constant through its iterations—an immersive virtual world that allows users across the globe to participate in activities and interact using their digital avatars.

How is the latest metaverse different than its predecessors? The aspirational features and related infrastructure development for the latest version of the metaverse are bringing the idea of a true digital world closer to reality than ever before. A confluence of advances in multiple fields, including but not limited to computational hardware, cloud software, content management, digital payments and flexible work schedules, have all played a part in the popular embrace of the metaverse. Some of the distinct features for this chapter of metaverse evolution that set it apart are as follows.2

  • Interoperability that underpins its scalability across multiple social platforms
  • A push to leverage both a faster decentralized internet (5G, Web 3.0) and untethered devices with sizable onboard computational power, to accommodate synchronous rendering and an unlimited number of users
  • Multi-disciplinary application areas that expand the scope and speed of its global acceptance; various estimates put metaverse-related revenue to hit approximately USD 800 billion by 2024, reflecting a CAGR of 13% since 20203

Focus on Core Building Blocks

Given the breadth of potential metaverse applications, our approach for constructing a metaverse index focuses on the following four pivotal themes, which in our view, form the backbone of the seamless metaverse experience.

  • XR Enabling Software and Applications: Software applications driving interactions within the high-capacity digital environments
  • XR Enabling Equipment: Hardware driving the immersive low-latency digital user experience
  • Infrastructure Technologies: Edge computing and cloud-based data infrastructure that will enable real-time capabilities
  • Digital Finance: Virtual payments and digital currencies that will facilitate frictionless commerce within the metaverse

Index Construction and Methodology Underscores Its Differentiation

With our metaverse index scope defined, we apply our innovative S&P Kensho Index construction methodology to generate the list of individual stocks eligible for inclusion. This procedure harnesses natural language processing techniques meshed with our experts’ oversight to define a rules-based approach in selecting U.S.-listed stocks whose business objectives and revenue disclosures include relevant text to the index’s focus areas. For our metaverse index, we limit the basket to companies whose core business is one of the four areas defined above, tailored to pick stocks essential to the theme. The S&P Kensho Metaverse Index has a relatively small overlap with Nasdaq 100 and S&P Software & Services Select Industry Index (see Exhibit 1), highlighting its emphasis on incipient stocks within this growing theme. The S&P Kensho Metaverse Index’s stock overlap even with some of its similar-themed competitors is roughly about one-half of its constituents. This can be attributed to our targeted sub-themes within the metaverse, which doesn’t have one stated consensus industry definition.

The S&P Kensho Metaverse Index’s current constitution (as of March 22, 2022) contains 30 stocks and is weighted primarily toward the Infrastructure Technologies segment (51%), followed by XR Enabling Software and Applications (36%), XR Enabling Equipment (10%) and Digital Finance (4%) (see Exhibit 2).

The S&P Kensho framework’s adaptive and forward-looking characteristics help to ensure current constituents’ continued relevance to the index’s theme, as well as room for new constituents to account for evolution within this nascent area. Additionally, our liquidity-adjusted equal weighting methodology seeks to reduce index concentration and increase its investability.

1 https://www.cnbctv18.com/business/industrial-ai-startup-detect-technologies-signs-global-pact-with-shell-12908962.htm

2 https://www.td.org/atd-blog/what-is-the-metaverse-where-we-are-and-where-were-headed

3 https://www.bloomberg.com/professional/blog/metaverse-may-be-800-billion-market-next-tech-platform/

4 For more information about these ETF holdings, please see the following websites: https://www.invesco.com/us/financial-products/etfs/product-detail?audienceType=Investor&productId=ETF-QQQM. https://www.fountetfs.com/product/mtvr. https://www.proshares.com/our-etfs/strategic/vers/. https://www.roundhillinvestments.com/etf/metv/. https://www.subversiveetfs.com/punk.

5 For more information about these ETF holdings, please see the following websites: https://www.fountetfs.com/product/mtvr. https://www.proshares.com/our-etfs/strategic/vers/. https://www.roundhillinvestments.com/etf/metv/. https://www.subversiveetfs.com/punk

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

Beyond Bitcoin: Why Digital Assets Need a Classification System

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James McDonald

Product Manager, Enterprise Data Team

Lukka

A few weeks ago, after communicating that I would be pivoting my career into the digital assets space and focusing on data, a long-time friend asked me, “Oh, you mean working with cryptocurrencies and helping people manage their bitcoins?” I paused and then explained that there is more to the digital assets markets than Bitcoin, and the deeper you go, the more interesting it becomes. However, the question stuck with me. I realized that my friend was not the only one with a narrow view of digital assets. The absence of a formal classification structure creates a barrier for new digital assets investors to understand the market segments beyond Bitcoin and Ethereum.

Three years ago, my friend would have been right. Cryptocurrency investing was generally thought of as buying Bitcoin or Ethereum, or maybe Litecoin. Today, that could mean anything—buying an NFT, discovering new ways to borrow, lend, and trade via DeFi protocols, or purchasing virtual real estate in Decentraland to make money renting the space out. This evolution is why investors and market participants are shifting their nomenclature from “cryptocurrencies” to “digital assets,” as the latter more accurately defines the emergence of a new asset class that extends beyond the original payment/currency-focused use cases.

How Diverse Is the Digital Asset Ecosystem?

While Bitcoin remains the dominant asset by market cap, the dominant sector for the top 50 assets is currently Smart Contract Platforms (sometimes also called “Layer-1s”). A digital assets investor may use this information to begin researching other emerging Smart Contract Platforms that are not in the top 50 and create an investment thesis derived from a comparable company analysis. This is not that dissimilar from how an equity manager may form an opinion on assets that may outperform their respective sectors. Similar to equities, this analysis would not be possible without first categorizing the universe of digital assets via a standardized sector classification system.

Why It Matters

The benefits of adopting a sector classification share one underlying similarity: they push forward the maturation of the digital assets asset class.

Traditional market participants are beginning to see that digital assets are not confined to a single use case, such as general payment, but are more accurately represented as a new asset class that is disrupting many legacy business verticals.

  • Standardized classification systems are a natural part of the growth of any new asset class—they can lead to new products and new allocation methodologies, as well as pave the way for increased adoption and legitimacy.
  • Sectoring digital assets could introduce many new capabilities within the digital assets markets and open the doors to a new era of legitimacy and acceptance from the traditional financial world.

Now that we have established there is more to digital assets than Bitcoin and Ethereum, stay tuned for our second piece outlining what a standardized classification system means for the emerging digital assets asset class.

 

Lukka’s Capabilities

Lukka is a firm that helps solve some of the greatest financial challenges in crypto, but has the intellectual resources, along with the data and processing capabilities, to test hypothetical scenarios like the one here. For more information on how Lukka puts data to work across multiple finance sectors, traditional and decentralized, supporting industries from insurance to Formula E, go to our website at Lukka.tech

 

DISCLAIMER

THE INFORMATION CONTAINED IN THIS BULLETIN PROVIDES ONLY A GENERAL OVERVIEW OF CURRENT  ISSUES RELATED TO DEBT FINANCING IN CRYPTOCURRENCY MARKETS AND SHALL IN NO EVENT BE CONSTRUED AS THE RENDERING BY LUKKA OF PROFESSIONAL ADVICE OR SERVICES. AS SUCH, THE INFORMATION PROVIDED IN THIS BULLETIN SHOULD NOT BE USED BY YOU AS A SUBSTITUTE FOR CONSULTATION WITH PROFESSIONAL ADVISORS. BEFORE MAKING ANY DECISION OR TAKING ANY ACTION REGARDING YOUR DIGITAL CURRENCIES OR THE DEBT TREATMENT THEREOF, YOU SHOULD ALWAYS CONSULT WITH AN APPROPRIATE FINANCIAL, LICENSED TAX, ACCOUNTING, OR OTHER PROFESSIONAL. TO THE FULLEST EXTENT PERMITTED BY LAW, IN NO EVENT WILL LUKKA(INCLUDING ITS RELATED ENTITIES, OWNERS, AGENTS, DIRECTORS, OFFICERS, ADVISORS, OR EMPLOYEES) BE LIABLE TO ANY READER OF THIS BULLETIN OR ANYONE ELSE FOR ANY DIRECT, INDIRECT, OR CONSEQUENTIAL LOSS OR LOSS OF PROFIT ARISING FROM THE USE OF THIS BULLETIN, ITS CONTENTS, ITS OMISSIONS, RELIANCE ON THE INFORMATION CONTAINED WITHIN IT, OR ON OPINIONS COMMUNICATED IN RELATION THERETO OR OTHERWISE ARISING IN CONNECTION THEREWITH.

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

Holding Period Returns

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Craig Lazzara

Former Managing Director, Index Investment Strategy

S&P Dow Jones Indices

What is the appropriate observational period for evaluating an investment strategy?

This question is important, because different observational periods can produce different conclusions. For example, for the first 11 weeks of 2022, one of our better-performing factor indices has been the S&P 500® Low Volatility Index. Through March 18, 2022, Low Vol had declined 4.7%, versus a 6.1% decline for the S&P 500. This incremental value, however, did not accrue smoothly. Low Vol outperformed in only six of the year’s first 11 weeks; in mid-February, in fact, its year-to-date performance lagged that of the S&P 500 by more than 100 basis points.

At some level, this is a silly comparison; no sensible analyst would worry about performance over a period as short as a week. But to say that a week is not an appropriate observational period does not tell us what an appropriate period is.

We reconstitute Low Volatility and other factor indices periodically; for Low Volatility, these changes take place quarterly in February, May, August, and November. Over the course of a year, therefore, Low Volatility holds four distinct baskets of stocks, and the holding period of each basket does not correspond to a neat unit of calendar time. When we look at February’s performance, for example, we’re looking at the performance of two different baskets, since a rebalancing transaction took place on Feb. 18, 2022.

Rather than using calendar units, therefore, a logical alternative is to make our observational period coincide with the index’s rebalancing schedule. We can ask not how Low Vol performed over a month or a quarter, but how each individual basket of low volatility stocks performed during its time in the index.

Low volatility strategies aim to dampen the returns of the parent index from which they are derived—to offer protection when the parent index declines and to participate (although regrettably not fully) when the parent index rises. If we examine months when the S&P 500 declines, Low Vol typically outperforms, and vice versa when the market rises. We’ve observed this result in low volatility strategies globally, and they confirm what our initial backtests of the low vol concept led us to expect.

We see the identical pattern when we observe distinct low volatility baskets rather than calendar months. The upper graph in Exhibit 1 shows that, for baskets held during periods when the S&P 500 declined significantly, Low Vol outperformed by an average of 4.79%; the lower graph shows that 82% of those baskets outperformed. As market performance improved, the relative performance of Low Volatility declined.

All observational periods are arbitrary, but some are more arbitrary than others. Using basket holding periods is arguably the least arbitrary option available. Its results support our understanding of the low volatility factor.

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

How Does the S&P Europe 350 ESG Index Work?

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Barbara Velado

Senior Analyst, Research & Design, Sustainability Indices

S&P Dow Jones Indices

Launched in 2019, the S&P Europe 350® ESG Index is designed to represent a broad-based, sustainable European benchmark. The index looks to provide an efficient tool for those aiming to focus on the European market, while aligning investments with ESG principles. Here, we dive into how the index achieves this—and why index design matters.

How Is the Index Designed?

The S&P Europe 350 ESG Index brings ESG considerations to the headline S&P Europe 350, which seeks to track the large-cap developed European market, spanning 16 countries. First, the index applies baseline exclusions by removing companies involved in business activities such as tobacco, controversial weapons and thermal coal. The index further removes companies in the bottom 25% by S&P DJI ESG Score within each industry group. Companies are then selected by their S&P DJI ESG Score, with the index targeting 75% of each GICS® industry group by market cap.

The Impact of Exclusions

When considering exclusions by industry group, Capital Goods and Food, Beverage & Tobacco are the most affected on absolute index weight terms. This is due to their high exposure to controversial weapons and tobacco (see Exhibit 2). When analyzing excluded weight as a percentage of its total industry group weight, Software & Services is the most affected, due to low S&P DJI ESG Scores.1

The Importance of S&P DJI ESG Scores

S&P DJI ESG Scores play a crucial role in the selection process for the S&P Europe 350 ESG Index. When considering each GICS industry group, companies with low S&P DJI ESG Scores may be eligible, but not selected. As scores improve, we see companies make it into the index (see Exhibit 3). This highlights the importance of integrating S&P DJI ESG Scores into the methodology, as it ensures the index not only removes companies involved in detrimental business activities, but selects the best sustainability performers.

What Does the S&P Europe 350 ESG Index Achieve?

Through this simple, rules-based approach, the S&P Europe 350 ESG Index accomplishes two parallel objectives:

  1. Raises the sustainability bar relative to its underlying index (see Exhibit 4); and
  2. Maintains an industry-group neutral composition relative to the underlying index.

The index shows enhanced sustainability characteristics, as well as dimensional environmental, social and governance improvements relative to the underlying index (see Exhibit 5).

By incorporating ESG criteria into a large-cap, broad-based European market, the S&P Europe 350 ESG Index establishes itself as the alternative, sustainable benchmark to the S&P Europe 350. It presents an efficient tool for market participants who increasingly place sustainability and ESG considerations at the core of their strategies.

1 Companies that have an S&P DJI ESG Score in the bottom 25% of scores within their GICS industry group in the S&P Global LargeMidCap and S&P Global 1200 are excluded.

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

India's ETF Market: Sustainability and Innovation

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Koel Ghosh

Former Head of South Asia

S&P Dow Jones Indices

The pandemic, along with its disruption, also opened windows to many opportunities. Innovation and new ideas are the key words. Sustainability is not a new idea; however, its focus has accelerated with the pandemic and incidents triggered by climate change. Nations and organizations are adopting ESG measures and bringing its importance to the forefront. Its incorporation into investment strategies has further emphasized its importance. The assets in sustainable funds have crossed USD 2.7 trillion, with over 5,900 funds.1 Europe dominates both in terms of assets and products, followed by the U.S. S&P DJI has had a long history of providing ESG indexing solutions, with some prominent indices such as the S&P 500 ESG Index, S&P Paris-Aligned & Climate Transition Index Series, and a host of options across core, thematics, factors, and fixed income.

In their quest for innovation, providers of financial strategies are evaluating options like the S&P Kensho Indices, which capture the industries and innovation of the fourth industrial revolution. This new generation of indices, powered by artificial intelligence, is designed to track innovation systematically and is helping market participants adopt a quantifiable framework to understand and measure innovation.

Can Passive Be the new Active?

The strong growth in passive investing is encouraging its prospects. India is seeing a heightened interest and the resultant product issuances. Active outperformance is being challenged by indexing strategies. The road to passive investment styles dominating markets is a long one, but with new milestones, there is optimism to get there.

1 MorningStar, https://www.morningstar.com/lp/global-esg-flows-, Global Sustainable Fund Flows: Q4 2021 in Review

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