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Canadian Equities Go the Way of Global Equities

Why What’s Inside the Style Box Matters

Rebalancing Report: The S&P/ASX 200 ESG Index

Opportunity to Outperform

Introducing the S&P 500 ESG Dividend Aristocrats Index

Canadian Equities Go the Way of Global Equities

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Fei Mei Chan

Director, Core Product Management

S&P Dow Jones Indices

There has been no shortage of macroeconomic headwinds in 2022. Canadian equities were an exception in posting gains for the first three months of the year, but they have since fallen in step with most global equity markets. The S&P/TSX Composite Index lost 12.07% since its last rebalance on March 17, 2022. Uncommonly, the S&P/TSX Composite Low Volatility Index underperformed slightly, losing 12.34% in the same period.

With the market’s decline, volatility has, unsurprisingly, increased for all sectors of the S&P/TSX Composite Index, with the Information Technology notching the biggest jump (see Exhibit 1).

The impact of these changes on the S&P/TSX Composite Low Volatility Index was limited, since the index had already eliminated all holdings in the Consumer Discretionary, Information Technology and Materials sectors. As of the latest rebalance, effective at the close of trading on June 17, 2022, Low Volatility continues to hold just eight sectors, with the largest concentrations in Financials, Real Estate and Utilities (despite Real Estate having been pared back 6%). Communication Services, Energy and Utilities all added to their weights.

 

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

Why What’s Inside the Style Box Matters

Take a closer look at the style spectrum with S&P DJI’s Garrett Glawe and explore how index construction influences risk/return.

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

Rebalancing Report: The S&P/ASX 200 ESG Index

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Daniel Perrone

Director and Head of Operations, ESG Indices

S&P Dow Jones Indices

The S&P/ASX 200 ESG Index recently underwent its annual rebalancing, and it was the first rebalance following the recent changes to the S&P ESG Index Series Methodology. As a result, 14 companies were added to the index and 23 companies were removed, with some high-profile names on the move. In this blog, we’ll discuss the methodology changes recently implemented and their impact on the index, and we’ll highlight a few key movers in and out of the index.

Effective with this rebalancing, companies with involvement1 in oil sands, small arms and military contracting became ineligible for the S&P ESG Index Series. At this point in time, there are no companies in the S&P/ASX 200 that have meaningful involvement in these areas, though the possibility exists for future entrants into the index to find themselves ineligible for the ESG version. In addition, the data source for compliance with the United Nations Global Compact (UNGC) has been updated from a continuous (scores ranging from 0 to 100) to a discrete (compliant/non-compliant) data set for greater transparency and easier interpretation. This modification also resulted in no immediate changes to the index.

Lastly, existing constituents of the S&P/ASX 200 ESG Index will begin to be reviewed on a quarterly basis to ensure they continue to meet the eligibility criteria for the index. This will ensure that changes to a company’s business profile that violate the index methodology are actioned upon in a timely manner.

The most noteworthy change to the index composition is the addition of Commonwealth Bank Australia (CBA) and subsequent removal of Westpac Banking Corp. (WBC). CBA’s controversies surrounding breaches of anti-money-laundering laws and complaints of fraud, poor financial advice and charges for services not provided to customers (all of which were captured by S&P Global’s Media & Stakeholder Analysis) have been well documented, though over the past two years, their S&P DJI ESG Score has recovered, as the company has made jumps in the areas of sustainable finance, climate strategy and human rights.

As such, CBA leapfrogged WBC in their industry group, moving up from being ranked fourth to third (by S&P DJI ESG Score) and resulting in its first-time addition into the index.

Additionally, another first-time eligible company was added to the index: Paladin Energy Ltd., part of the GICS® Energy industry group. Paladin Energy was added to the underlying S&P/ASX 200 last December. In many cases, new additions to an index result in a corresponding drop from the same industry group. In this case, Worley Ltd., whose S&P DJI ESG Score dropped 12 points from 42 to 30, was removed from the index.

Overall, the 14 additions to the index represented just over AUD 268 billion in float-adjusted market capitalization (as of April 29, 2022, the index rebalancing date), with the 23 drops totaling over AUD 174 billion. The changes implemented as part of this rebalancing ensure that the index continues to provide broad-market exposure to the Australian market alongside an improved sustainability profile.

 

1 Exact revenue thresholds for eligibility can be found in the S&P ESG Index Series Methodology.

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

Opportunity to Outperform

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Anu Ganti

Senior Director, Index Investment Strategy

S&P Dow Jones Indices

It’s been a challenging year for U.S. equities as investors adjust to a new rising rate regime, with inflation concerns at the forefront, coupled with uncertainty around future economic growth. Market commentators have argued that this environment is ideal for stock pickers to shine.

This argument is correct, but with a caveat. With the S&P 500® down 13% year-to-date through May 31, we are in precisely the environment in which skillful active portfolio managers have the most potential to add value, since relative returns are easier to achieve when absolute returns are poor. Poor returns are usually accompanied by increased market volatility, and high volatility can help active managers in two distinct ways.

Higher volatility can manifest itself as both higher dispersion and higher correlation. Higher dispersion means a wider gap between winners and losers, while higher correlation indicates a tendency for stocks to move together. The value of stock-selection skill rises when dispersion is high: a more significant gap between winners and losers means that active managers have a better chance of displaying their stock-selection abilities. Exhibit 1 shows that dispersion levels in the S&P 500 have increased since Q3 2021 and are currently above their historical average.

While more subtle than the obvious advantage of high dispersion, active managers should also prefer high correlations over low correlations. Because active portfolios are typically more concentrated and more volatile than their index benchmarks, active managers forgo a diversification benefit. When correlations are high, the benefit of diversification falls, as does the benefit forgone, making active management easier to justify.

Exhibit 2 shows that as macro risks have risen, so too have correlations; in fact, the reading of 0.48 as of May 2022 is the highest since September 2020.

Both high dispersion and high correlations are now working in active managers’ favor. Higher dispersion means that the value of selection skill rises, while higher correlation implies a lower volatility hurdle to overcome. However, high potential for outperformance does not automatically translate into actual outperformance. There is an equally high potential for embarrassment for stock pickers without the requisite skill. When SPIVA® results for year-end 2022 become available next year, we will learn how many active managers were able to capitalize on this opportunity.

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

Introducing the S&P 500 ESG Dividend Aristocrats Index

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George Valantasis

Associate Director, Strategy Indices

S&P Dow Jones Indices

Investors are increasingly aspiring to align their investment objectives with their personal and societal values. At the same time, dividends are at the top of investors’ minds, as monetary policies tighten globally and volatility in the financial markets increases. In light of these trends, S&P Dow Jones Indices (S&P DJI) recently launched the S&P 500® ESG Dividend Aristocrats® Index, the latest addition to the S&P ESG Dividend Aristocrats Indices family.

A Focus on Dividends and ESG

Exhibit 1 details the methodology of the S&P 500 ESG Dividend Aristocrats Index. The rules are consistent with the S&P 500 Dividend Aristocrats Index plus an ESG overlay. First, the index selects companies in the S&P 500 that have consistently increased dividends every year for at least 25 consecutive years. Next, multiple ESG screens are applied. The index excludes companies in the lowest quartile of S&P DJI ESG Scores.1 Additional ESG exclusion reviews are conducted quarterly based on business activities,2 United Nations Global Compact (UNGC) breaches3 and a Media and Stakeholder Analysis (MSA)4 controversy filter. Lastly, the remaining constituents are equally weighted and rebalanced quarterly.

Comparison of S&P DJI ESG Scores and Dividend Yields

Turning to the index characteristics, Exhibit 2 shows that the S&P 500 ESG Dividend Aristocrats Index offered notable S&P DJI improvement over the S&P 500 Dividend Aristocrats Index. The S&P DJI ESG Score was improved, on average, by approximately 11.5 points per year, more than an 18% annual improvement.

Looking at Exhibit 3, the S&P 500 ESG Dividend Aristocrats Index and the S&P 500 Dividend Aristocrats Index have had comparable yields, and both have held a significant yield advantage over the S&P 500. Over the full period examined, the average annual dividend yields for the S&P 500 ESG Dividend Aristocrats Index, S&P 500 Dividend Aristocrats Index and S&P 500 were 2.35%, 2.38% and 1.88%, respectively.

Performance

Exhibit 4 shows that the S&P 500 ESG Dividend Aristocrats Index has generated higher risk-adjusted returns over the 3, 5, 7, 10 and full year periods versus the S&P 500 Dividend Aristocrats Index and S&P 500.

Interestingly, as financial conditions have tightened materially since the start of 2022, companies with consistent dividend payments have outperformed the broad market. Year-to-date, the S&P 500 ESG Dividend Aristocrats Index and the S&P 500 Dividend Aristocrats Index have outperformed the S&P 500 by 7.02% and 6.89%, respectively.

This may be due to two reasons; first, because cash returned to investors is more valuable now that real interest rates are rising,5 and second, because a company’s ability to consistently increase dividends could signal a durable business model that is well positioned to outperform throughout the business cycle.

When it comes to the goal of pairing consistent dividend paying companies with investment objectives that align personal and societal values, the S&P 500 ESG Dividend Aristocrats Index could be an option to consider.

 

  1. The S&P DJI ESG Scores are the result of further scoring methodology refinements to the S&P Global ESG Scores that result from S&P Global’s annual Corporate Sustainability Assessment, a bottom-up research process that aggregates underlying company ESG data to score levels.
  2. Companies with the following specific business activities are excluded: controversial weapons, thermal coal, tobacco products, oil sands, small arms and military contracting.
  3. As of each rebalancing reference date, companies classified as non-compliant with the United Nations Global Compact principles according to Sustainalytics are ineligible for index inclusion.
  4. The MSA monitors a company’s sustainability performance on an ongoing basis by assessing current controversies that could potentially threaten a company’s reputation or financial health.
  5. https://fred.stlouisfed.org/series/DFII10.

 

 

 

 

 

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