Indexology^® Blog

I am deeply honored to assume the chairmanship of the Index Industry Association (IIA) this year. Since 2012, the IIA has been a tireless advocate for independent index providers globally. As the IIA celebrates its 10^th anniversary this year, now more than ever, our role in educating people about how indexing has transformed and democratized access to financial markets is crucial.

Indeed, indexing has rapidly evolved over the past three decades, growing from a relatively niche and obscure segment of the global financial market into a mainstream part of investing, retirement saving and generational wealth-building.

Today, global index providers collectively offer roughly three million indices that track and measure the broader markets as well as more targeted market sectors and segments. This means that overall, the indexing industry is ripe for competition and innovation.

Transparency has been a founding principle of the IIA, with its members committing to making index methodologies publicly available. Thanks to transparency and independent indices, there are more data and insights available today to help us better understand and evaluate market risks, returns and opportunities. Indices help investors make informed decisions to meet a wide range of financial goals.

Indices themselves have been around for a long time. Iconic gauges such as the Dow Jones Industrial Average^® (DJIA), the S&P 500^® and many other benchmarks are not only tracking the market’s daily ups and downs but are also reflecting its most pivotal moments. For example, indices have borne witness to the changing fortunes of the corporate world, industry shifts in the global economy and the rise of new companies. Indices reflect the market’s history and longevity and provide an eye toward its future.

The value and benefits that indices and indexing have brought to global markets cannot be underestimated. While independent index providers do not manage money, trade or develop investment strategies, indices are licensed and utilized as building blocks for index-based financial products such as exchange-traded funds (ETFs). The demand for indices and index-based products such as ETFs continues to grow, driven by their transparency, efficiency and low cost.

An S&P Dow Jones Indices study illustrated the strength of savings derived from indexing over the past 25 years. S&P DJI estimated that indexing has generated approximately USD 357 billion in cumulative savings in management fees. This study used three of S&P DJI’s core U.S. equity indices as a sample. If we consider the cumulative benefits derived from all the indices available linked to ETFs and other index-based investment products, the aggregate amount of savings would likely be far higher.

In addition to lower costs, performance is another key driver of the growth of indexing and the shift to index-based or passive investing from active management. S&P DJI has been tracking the performance of actively managed funds versus their respective indices and has found that active managers, which typically charge higher management fees, tend to trail their benchmarks in terms of performance. In the SPIVA^® U.S. Year-End 2021 Scorecard, S&P DJI found that more than 80% of U.S. large-cap funds underperformed the S&P 500 over a 10-year period. Indices and indexing with their cost benefits have contributed to increased market competition. Ultimately, it seems that healthy competition among index providers and a diversity of choice benefit end investors.

Indices and the indexing industry as a whole will continue to reflect the ongoing evolution of global financial markets. Since its founding a decade ago, the IIA has served as a unified voice for the indexing industry and remains committed to maintaining an open and constructive dialogue with a diverse group of market participants and stakeholders.

The IIA and its members recognize their important contributions to and role in the broader financial ecosystem and will continue to uphold the highest standards of integrity and transparency in our industry to promote sustainable global financial markets and foster healthy competition and innovation.

This article was first published on the Index Industry Association website on March 31, 2022, as part of the series Voices of IIA.

The years between 2017 and 2021 were a frustrating half-decade for value investors. The S&P 500 Growth Index advanced at a compound annual rate of 24.1%, more than double the 11.9% return of its Value counterpart. Despite occasional (and sometimes prematurely celebrated) periods of success, Value underperformed Growth in four years of the five (and its win in 2019 was close).

In the first four months of 2022, however, the style winds shifted, as Value (-5.0%) dramatically outperformed Growth (-20.0%). Exhibit 1 puts this difference in historical context, comparing January-April 2022 to all other trailing four-month intervals in our database. The 15% gap between Value and Growth is obviously high by historical standards, and represents a dramatic reversal from recent trends. (As recently as nine months ago, the gap favored Growth by more than 10%.)

Exhibit 2 examines the same data with a 12-month lookback. The acceleration of Value’s performance is nearly as impressive from this perspective. At the end of April 2022, Value was 6.5% ahead of Growth; just five months ago, for the year ending November 2021, Growth was 13.3% ahead of Value.

For either lookback period, the conclusions are clear: Value has outperformed Growth to a historically uncommon degree, and this differential has accelerated quite dramatically in the last year.

What does this portend for the future relative performance of Value and Growth?  Spoiler alert: I don’t really know, but there are at least some reasons to suspect that Value’s advantage may weaken in the near term.  Exhibit 3 compares the current Value-Growth spread to its historical level.

Value’s 15% differential for the first four months of 2022 was not only visibly above average, it’s at the 98^th percentile of all such spreads in our historical data. The only higher readings came in the deflation of the technology bubble more than 20 years ago. Comparing Pure Value and Pure Growth produces much the same result. The trailing 12-month data suggest a similar, if somewhat less extreme, conclusion, with Value’s outperformance just into the top quartile of its history. (Similar analysis for mid- and small-cap style indices show much the same results.)

The fact that a data point is high in its historical distribution doesn’t mean that next month’s observation can’t be equally high, or higher. There’s no guarantee, for that matter, that the distribution is stable, and that the next observation won’t surpass the previous all-time record. That said, history suggests that the torrid outperformance of Value is unlikely to continue, at least in the short term, and that the next big move in the Value-Growth differential is more likely to be down than up.

Similar to active managers, who attempt to identify stocks with above-average performance, investors who use active funds aim to identify managers who will outperform their peers. Our SPIVA^® Scorecards consistently show that most active managers underperform most of the time. But not all funds, and not all the time. How might such outperforming funds be identified in advance?

Notwithstanding the commonly used disclaimer that “past performance is no guarantee of future results,” one obvious place to search is among those funds that outperformed in the past. However, the reliability, if any, of history as a guide to manager selection is critical: examining the persistence of active success helps us disentangle managers with true skill, from those simply visited by good fortune.

Our Persistence Scorecards measure the degree to which historical relative performance predicts future relative performance. One measure included in the report is the proportion of funds that were top quartile (versus their peers) that remained so over various time periods. Sourced from our U.S. Persistence Scorecard Year-End 2021, Exhibit 1 shows that only 27% of top-quartile U.S. large-cap funds from December 2011-December 2016 remained in the top quartile for the next five years, slightly above the 25% rate we’d see if performance were completely random. Meanwhile, U.S. mid- and small-cap funds performed even worse. A miniscule 1% of top-quartile U.S. mid- and small-cap funds remained in the top quartile during a subsequent five-year period, refuting a common assertion that it is easier to sustain outperformance within the smaller-cap space.

More importantly, these performance persistence problems are not unique to the U.S, with similar results across Canadian, European, Latin American and global emerging markets,¹ as illustrated in Exhibit 2.

Extending our time horizon, Exhibit 3 shows there is an exponential decrease in persistence over longer time periods. For example, while 25% of Canadian Small-/Mid-Cap Equity funds maintained their top status over three consecutive years, that number dropped drastically to zero over a five-year period. Funds across regions fared no better, with none of the U.S. Small-Cap, Canadian, Brazil or Mexico Equity funds able to stay in the top quartile over five consecutive years, indicating that when outperformance does in fact occur, it tends to be fleeting. 

Unsurprisingly, the worst-performing funds across regions are likely to end up merging or liquidating. We see in Exhibit 4 that on average almost 40% of fourth-quartile funds globally disappeared over a subsequent five-year period.

The lack of persistence among active managers globally is not a new phenomenon. These results suggest that short-term success, when it occurs, may arise as much from luck as from genuine stock selection skill.

¹ Benchmark is the S&P/IFCI Composite for Euro-denominated Emerging Markets Equity funds.

Since the launch of the S&P Cryptocurrency Indices in 2021, we often get asked about the difference between a price (more formally known as a reference rate) and a single-coin index.

So, let me unpack this into three questions:

1. What is a reference rate?
2. What is a single-coin index? And especially, why is it different from a reference rate?
3. What is the value of an index overall?

 Crypto Reference Prices

Simply put, a reference price for a cryptocurrency is the price for which one can buy that coin (or token) from an exchange. This is often referred to as the crypto price.

Beyond that, cryptocurrency pricing is anything but straightforward.

In fact, in cryptocurrency markets, we believe that one of the biggest challenges is access to robust, transparent pricing.

• The cryptocurrency market is decentralized, with hundreds of exchanges operating globally 24/7. This means there is no one definitive market price nor the concept of a “consolidated tape,” as exists for equity prices.
• The quality of exchanges varies widely—in terms of operational aspects, the regulations to which they are subject, their governance practices, and the security and robustness of their platforms.
• Exchanges vary in terms of the robustness of their trading volume, liquidity and pricing.
• It is a challenge to obtain a unique indication of price from these exchanges.

S&P DJI’s selection of Lukka, an institutional-quality crypto price aggregator, as our price provider for the cryptocurrencies used in our indices gives us the ability to use standardized cryptocurrency data selected from a set of comprehensive and reliable exchanges in our indices.

Single-Coin Indices

The goal of a single-coin index, unlike a crypto reference price, is to reflect what happens if a single user buys a single coin and what its returns are from that point on. The S&P Bitcoin Index is intended to do this for Bitcoin.

While the concept is quite simple, making sure that the methodology is rules based and the calculation is accurate requires a number of adjustments to ensure the index fully reflects returns on the asset and its value over time. As part of the index methodology, S&P DJI takes Lukka’s price and applies a base value to it. For the S&P Bitcoin Index, the base value is 100 on Jan. 1, 2014. The level of the index is calculated to represent the changes in the reference price from day to day and shows the change in relative value over time.

In addition, the S&P Bitcoin Index, as well as the other S&P Cryptocurrency Indices, adjust for coin supply (akin to shares outstanding) and coin events (akin to a corporate action). Coin events include forks, air drops and staking rewards (see page 12 of the methodology for more details). These features all distinguish a single-coin index from a reference price and make the index value different than a reference price.

Index Benefits and Uses

The benefits of an index are to bring transparency and accessibility to markets. Indices allow market participants to understand the relative growth of an asset class. In the case of crypto, the S&P Cryptocurrency Indices help clarify the relative growth of various cryptocurrencies and the overall cryptocurrency market over time.

Many investors benchmark their investments to indices to determine whether their investments are outperforming or underperforming the markets in which they invest. Other investors want the precision of an index when they benchmark their returns—for example, price return versus total return, time of the index, and type of pricing (fair market value, volume-weighted average price, etc.).

Most importantly, for financial institutions looking to create an index-linked investment product—such as a Bitcoin ETF—an index is a necessity.

Learn more about the S&P Cryptocurrency Indices here.

Another higher inflation reading helped the S&P GSCI, the broad commodities benchmark, to post an additional 5.1% gain in April. Many market participants realized the U.S. Fed may be behind the curve and have started allocating capital to commodities in 2022. Agriculture and energy continued to outperform last month, while metals and livestock underperformed. Among the major asset classes, commodities’ outperformance YTD is striking (see Exhibit 1).

The S&P GSCI Energy rose another 9.0% in April, with an impressive 59.2% YTD performance. Natural gas and heating oil led the way for the month, rising 26.9% and 24.7%, respectively, as the major crude oil grades continued to consolidate from the March peak in prices. Demand for U.S. natural gas exports rose dramatically this year with the global push to break dependence on Russian supplies. Natural gas production in the U.S. has slowed and the Energy Information Administration increased its price forecasts for 2022 to reflect this supply/demand imbalance.

Consolidation was evident in the metals markets in April. The S&P GSCI Industrial Metals declined 7.6%. Copper and aluminum fell notably, as COVID-19 restrictions in top consumer China and the growing likelihood of aggressive interest rate hikes fueled concern of weaker global growth.

Gold’s appeal waned in April. While gold is perceived as an inflation hedge, higher short-term U.S. interest rates and bond yields tend to increase the opportunity cost of holding a zero-yield asset such as the yellow metal. The S&P GSCI Precious Metals ended the month down 2.1%.

The S&P GSCI Agriculture gained 5.8% over the month, propelled higher by strong performance across the grains and oilseeds complex. The stand-out performer for the month was corn; the S&P GSCI Corn rallied 9.6%. U.S. corn planting in the last week of April was the slowest pace since 2013; the risk of late corn planting is that the crop is likely to pollinate later, and that can often feature hotter, yield-limiting temperatures. U.S. corn predominantly pollinates in July. The S&P GSCI Soybean Oil rose to record levels in April, ending the month up 23.0%. Access to oils for making food and fuel has been thrown into disarray, as war in Ukraine and weather-driven supply woes reduced availability, and the situation was exacerbated in April following Indonesia’s sweeping ban on palm oil exports.

Livestock markets struggled in April under the weight of higher feed costs and the protracted lockdown across China, a key export market particularly for U.S pork. The S&P GSCI Livestock ended the month 6.9% lower.