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Ship Ahoy: Introducing the S&P GSCI Freight Indices

Time Sensitivity and Volatility Management

Commodities Rise 36% in 2022 after a Flat July

Schrödinger’s Carbon: Intensity and Paris Alignment

What Fixed Income Index Liquidity Means for Insurers

Ship Ahoy: Introducing the S&P GSCI Freight Indices

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Fiona Boal

Head of Commodities and Real Assets

S&P Dow Jones Indices

On Aug. 1, 2022, S&P Dow Jones Indices (S&P DJI) launched a series of S&P GSCI Freight Indices, the first of their kind in the market and an expansion of the single-commodity offering of indices based on the S&P GSCI. The S&P GSCI Freight Indices are designed to provide reliable and publicly available performance benchmarks for the largest dry bulk freight markets. The indices are based on the Baltic Exchange’s monthly and quarterly forward freight agreements (FFAs). The index series includes the following.

As the main shipping derivative instrument, FFAs track the average daily chartering cost (vessel income) for a standard-sized vessel that performs a voyage via one of the main shipping routes. FFAs are cash-settled futures contracts that are traded over the counter via voice brokers and are subsequently novated to exchanges such as SGX, ICE, CME and EEX for clearing and ongoing margin management. These contracts have traditionally been used by shipowners and commodity trading houses for hedging their freight exposure.

The dry bulk market is the largest of the shipping sectors and has the deepest and most liquid FFA market. The sector is dominated by two vessel types, Capesize and Kamsarmax (referred to as Panamax for legacy purposes). FFA volumes in these vessel types explain essentially all of the underlying physical dry bulk market flows, so indices based on these contracts are a logical first foray into the dry bulk market for financial industry participants.

  • Capesize: broadly the largest standard size of the dry bulk carriers. Vessels carry mainly iron ore and coal and are employed across a small number of routes, typically moving cargos from Australia and Brazil to China.
  • Panamax: the second-largest standard size of the dry bulk carriers. Vessels carry coal, grains and other agricultural products as well as iron ore, and minor bulks such as bauxite, alumina, copper, phosphate rock and cement.

Exposure to freight rates varies by vessel type and trade route, although in most cases, freight represents a noticeable percentage of the final value of a commodity. For example, on average, freight accounts for 20% of the overall cost of iron ore exported from Brazil to China. As a major component of the cost of raw materials, it is important for financial market participants to have access to replicable and investable dry bulk freight indices.

Disruptions to global supply chains over the past few years have put the global freight market in the spotlight, highlighting its important link in the chain of the world economy and contribution to international trade. Freight rates are driven by the balance between demand for seaborne trade and supply of cargo capacity. The former is correlated to economic activity and industrial production and is also affected by prevailing demand conditions in specific commodity markets. The latter depends on the size of the global fleet, its utilization rates and, as witnessed during the COVID-19 pandemic and more recently the Russia-Ukraine conflict, shocks caused by disruptions to the free movement of people and vessels.

As global market participants increasingly seek to diversify their investments and look for alternative vehicles to tap into the niche market segments, the S&P GSCI Freight Index Series could be a meaningful gauge of global economic activity, seaborne trade and individual commodity and geographic market dynamics.

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

Time Sensitivity and Volatility Management

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Craig Lazzara

Managing Director, Core Product Management

S&P Dow Jones Indices

We all know that in the long run, the U.S. stock market has performed very well, compounding at well over 10% per year for nearly a century. We also know that sometimes the market performs very poorly, as the S&P 500®’s 20% decline in the first half of 2022 reminds us. For an investor who has the luxury of time, the combination of long-term gains with occasional pullbacks is a feature, not a bug; short-term declines are at worst a nuisance, and at best a buying opportunity.

For some investors, however, time is a luxury they do not have. Individuals often have specific goals to which finite time horizons attach. Such investors can benefit from the equity market’s long-term strength, but may have above-average sensitivity to short-term declines.

Defensive factor indices can help resolve this tension. Factor indices in general are designed to indicize active strategies—i.e., to deliver in passive form a pattern of returns that the investor would otherwise have to pay active fees to obtain. Exhibit 1 shows the relative risk and return of several S&P 500-based factor indices. Given the risk/return profiles in the exhibit, we can classify factor indices as either risk enhancers or risk mitigators—mitigators to the left, enhancers to the right.

We think of Low Volatility as the quintessential risk mitigator. Exhibit 2 shows why, comparing two efficient frontiers, one constructed using the S&P 500 and bonds, and the other using the S&P 500 Low Volatility Index and bonds.

For the period summarized in Exhibits 1 and 2, Low Volatility outperformed the S&P 500, but with lower risk. It’s therefore not surprising that an efficient frontier using Low Volatility as the risky asset dominates a frontier using the S&P 500. A 60/40 equity/bond allocation using Low Volatility experienced both lower risk and higher return than a 60/40 mix using the S&P 500.

Importantly, time-sensitive investors could use Low Volatility to improve their risk/return tradeoff. A 60/40 mix of the S&P 500 and bonds produced a total return of 8.3%, with a standard deviation of 8.8%. By using Low Volatility as the equity vehicle, the same return could have been achieved at a lower risk level (6.9%) and with a lower equity exposure (55%). Alternatively, using Low Volatility as the equity vehicle would have increased returns to 9.3% with the same risk level. Indeed, regardless of the starting point, shifting any part of an equity allocation from the S&P 500 to the S&P 500 Low Volatility Index would have resulted in both a reduction in overall risk and an increase in return.

What is true of Low Volatility is also true of other defensive factors. Time-sensitive investors should consider the record of defensive factor indices in mitigating short-term declines while retaining the long-run benefits of equity exposure.

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

Commodities Rise 36% in 2022 after a Flat July

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Jim Wiederhold

Associate Director, Commodities and Real Assets

S&P Dow Jones Indices

The S&P GSCI remained flat in July, holding on to a 36% YTD gain despite the bearish sentiment permeating the broad financial markets. This benchmark for world commodities has proven its merit during extremely hot inflation. The Fed hiked interest rates another 75 bps to fight inflation late in the month, but several factors across commodity sectors kept prices sticky in July.

Energy was mixed, as most petroleum commodities continued to come off their highs from earlier in the year. U.S. crude oil exports hit an all-time high on the back of overseas demand due to the big discount for WTI crude oil compared to Brent crude. The S&P GSCI Petroleum fell 3.0% while holding on to a still very strong 59.5% YTD gain. Natural gas, on the other hand, spiked higher to levels not seen since 2008 due to extreme temperatures around the globe requiring extra energy to cool buildings coinciding with Russia’s continued tightening of energy supplies to the EU. The S&P GSCI Natural Gas rose an impressive 54.4% in July, taking its lead from the extreme natural gas prices seen across the Continent. Late in the month, the EU agreed on a plan to ration natural gas use over the winter, just as Russia cut natural gas flows on the major pipeline from Russia to Germany to just 20% of capacity. French power prices rose to a new record high in July after a record low nuclear power generation recently.

With the pessimistic views on the deterioration of the global economy, The S&P GSCI Industrial Metals was flat last month. The S&P GSCI Copper was down 3.9%, but there are signs stabilization may be starting to sprout. A major rating agency in Shanghai came out with a report saying that it sees a V-shaped recovery, as China’s retail sales were up 22% year-over-year in June and passenger vehicle exports grew 40% year-over-year for the second quarter of 2022.

Reports of a deal between Russia and Ukraine that would allow grain to leave the Black Sea helped ease the supply concerns rampant within the agricultural space in July. Prices were also pressured by the upcoming northern hemisphere harvest and the consensus that yields in the U.S. will be similar to last year or better. The S&P GSCI Grains ended the month down 3.4%.

The S&P GSCI Precious Metals broke lower by 2.2% to levels not seen in two years. Typically seen as an inflation hedge, gold has not lived up to the reputation after prices have moved lower while inflation has moved rapidly higher. While sovereign nations’ appetites for gold has continued to hold up, aggressive rate hikes from the U.S. Fed have suppressed gold’s appeal. The drop in industrial activity suppressed silver prices over the month.

The bright spot within commodities in July came from the Livestock sector. The S&P GSCI Lean Hogs rose 11.9% on the back of U.S. hog herd concerns and lower feed prices. Seasonal summer demand for meat continues to be strong this year.

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

Schrödinger’s Carbon: Intensity and Paris Alignment

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Maya Beyhan

Senior Director, ESG Specialist, Index Investment Strategy

S&P Dow Jones Indices

In quantum mechanics, Schrödinger’s Cat refers to the paradoxical consequences of a thought experiment: can a cat be simultaneously dead and alive? A similarly counterintuitive phenomenon can be found in the context of climate-based analysis: whereby an index may boast a relatively low carbon intensity and yet, perhaps surprisingly, not be judged as aligned with the goals of the Paris Agreement. A case study illustrates the importance of considering both point-in-time and forward-looking analysis in understanding the results, as well as the value of sector-based perspectives.

Two S&P 500®-based indices, the S&P 500 ESG Index and S&P 500 Fossil Fuel Free Index, offer a particularly illuminating example. The point-in-time and forward-looking components of our analysis are provided, respectively, by the index-weighted carbon intensity and via the S&P Global Trucost Paris-Alignment dataset.1

As reported in S&P DJI’s new Climate and ESG Index Dashboard, the S&P 500 Fossil Fuel Free Index achieved a carbon intensity reduction of 10.6% relative to the S&P 500, while the S&P 500 ESG Index achieved a higher carbon intensity reduction of 21.0%.2, 3 But such figures are based only on the most recent emissions figures of constituents—a point-in-time perspective.

The results of the forward-looking analysis show a different picture: the S&P 500 ESG Index achieves a Paris-Alignment score of > 3°C, notably even higher than the benchmark S&P 500’s score of 2-3°C. On the other hand, the S&P 500 Fossil Fuel Free Index receives a score of 1.5-2°C. Exhibit 1 provides further detail, including a sector-level breakdown for each of the three indices.

Exhibit 1 also illustrates a sectoral perspective on the drivers of the index scores: the S&P 500 ESG Index holds a weight of 7% in sectors with a Paris-Alignment score of > 5°C, 4% higher than the S&P 500 Fossil Fuel Index’s weight, and a little higher than the S&P 500’s. Conversely, the S&P Fossil Fuel Free Index has a 73% weight in sectors with a 1.5-2.0°C alignment and only a 3% weight in > 5°C-sectors.

Alignment levels across sectors are highly dispersed, as Exhibit 2 emphasizes. By a significant margin, Energy companies have the weakest level of alignment, while Financials, Health Care and Real Estate, with typically lower direct emissions, show better results. The same applies to new economy sectors like Information Technology, where cost-effective abatement technologies have been easier to develop in comparison to “old economy” sectors, such as Materials.

The Utilities sector brings us back to the paradox set out in the beginning: the sector is well known as the highest direct emitter, and yet Exhibit 2 shows it has the second-highest proportion aligned with a < 2.0°C scenario of any sector. But a company with high current emissions may also be on a strong improvement trajectory, and large emitters can be very well aligned under transition pathway assessments. This is the case for the Utilities sector overall; a little like the infamous half-alive quantum feline, it is both dirty and clean.

Such examples illustrate the nuanced distinctions between carbon intensity and decarbonization trajectory. A detailed look at how the S&P DJI’s suite of indices performs in both dimensions is now offered free on a quarterly basis via our newly launched Climate & ESG Index Dashboard.

Register here to receive quarterly insights and performance attributions for our range of flagship ESG and Climate indices.

 

1 The dataset allows for the identification of the scale of company-level reductions required by 2030 and beyond to meet various climate-related objectives, such as a 1.5°C or 2°C maximum increase. More details may be found here.

2 All figures as of June 30, 2022. For more details, please refer to S&P DJI’s Climate & ESG Index Dashboard.

3 The S&P ESG Index Series does not have an explicit objective of reducing GHG or to align with any particular climate scenario.

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

What Fixed Income Index Liquidity Means for Insurers

How are index-based strategies helping insurers measure and address liquidity in their portfolios? Take a closer look at the why index liquidity matters with S&P DJI’s Nick Godec, Morgan Stanley’s Meredith Shaw, and BlackRock’s James Winslow.

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