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Defense and Volatility

Indexing the Performance of the E-Commerce Ecosystem

The Power of Style

SPIVA Institutional and the Pharaohs of Finance

Tucking in to the SPIVA Australia Mid-Year 2022 Scorecard

Defense and Volatility

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Craig Lazzara

Managing Director, Core Product Management

S&P Dow Jones Indices

As the equity market has waned and waxed in 2022, investor interest has naturally turned toward ways of mitigating portfolio losses. Some factor indices can serve this goal, but investors searching for a defensive strategy need to define their search carefully.

It’s natural to think that defensive strategies will be less volatile than the market as a whole, and this is a useful intuition. Some factor indices, in fact, have produced lower-than-market volatility with greater-than-market return. When such indices are combined with fixed income securities, the resultant efficient frontier often dominates combinations of fixed income with a cap-weighted market index.

That said, the essential requirement of a defensive index is not that it reduce volatility, but rather that it demonstrate a particular pattern of relative performance. Defensive factor indices aim to reduce losses in a declining market while also participating in rising markets. We often summarize this by referring to the “two Ps”—protection (in down markets) and participation (in up markets), while stressing that neither P is perfect.

Importantly (and counterintuitively), defensive indices are not necessarily less volatile than the benchmark from which they are derived, as Exhibit 1 illustrates.

The hypothetical factor index in the exhibit outperformed its hypothetical benchmark, although with higher volatility. Yet it is clearly a defensive index. When the benchmark rises, the factor is more likely to underperform than to outperform, and its average value added is negative. When the benchmark declines, the factor is more likely to outperform, and its average value added is positive. It delivers, in other words, on both Ps, participating in up markets and protecting in down markets.

Defensive indices will typically be less volatile than their parents. But not always. Investors seeking a defensive profile should take care not to rely on volatility statistics alone.

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

Indexing the Performance of the E-Commerce Ecosystem

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Claire Yi

Former Analyst, Strategy Indices

S&P Dow Jones Indices

Introduction to the E-Commerce Ecosystem

E-commerce is the abbreviation for electronic commerce, which is the purchasing and selling of goods and services, or the transmitting of funds or data, using the internet for the whole or part of a transaction. Usually, sellers utilize e-market platforms to open online storefronts, and buyers use the platform to shop for specific items. Sellers rely on technology companies to build infrastructures such as websites, analytics tools and cloud services. They also utilize social media to drive traffic, promote offerings and gain insights. Digital payment solutions enable buyers and sellers to close the transaction without offline interaction. These components together form the e-commerce ecosystem.

The history of e-commerce can be traced back to 1969, when Dr. John R. Goltz and Jeffrey Wilkins established the first e-commerce company, CompuServe.1 In the 1990s, many game-changing events in this industry happened, such as the arrival of the World Wide Web and the launch of online marketplaces like Amazon (1995), eBay (1995) and Alibaba (1999). PayPal rolled out the first e-commerce payment system to process fund transactions in 1998. Meanwhile, search engines such as Yahoo! and Google were established, which made online searching and marketing easier. Post-2000, e-commerce developed rapidly. UNITAD’s data shows that e-commerce’s share of global retail trade went from almost 0% 20 years ago to about 17% in 2020.2

The COVID-19 pandemic in 2020 forced most consumers to shift from offline to online shopping. However, in the past 18 months, e-commerce companies faced strong headwinds from the reopening of the economy, tightening regulation and lowered valuation under rate hikes.

Index Construction

S&P DJI recently launched the S&P Global E-Commerce Ecosystem Index, which is designed to track the performance of companies that have business exposure to e-commerce. In order to capture the whole value chain, the index identifies four business areas relevant to the ecosystem: online retail, social media, electronic payment and direct e-commerce support and solutions. Exhibit 1 shows the index weight breakdown of business areas.

We utilize FactSet’s Revere Business Industry Classification System (RBICS) data to select and assign scores to companies. Companies must generate at least 20% of revenue from e-commerce-related business or have an RBICS focus on any of the determined sub-industries (see details in the methodology). Then, companies will be assigned an exposure score of 1/0.75/0.5, depending on their aggregated percentage of revenue related to e-commerce (see Exhibit 2). Each of the RBICS sub-industries is mapped to one of the four business areas in the ecosystem (see details in Exhibit 5). The top 50 constituents are selected and weighted based on the product of total market capitalization and exposure score to balance the index capacity and exposure purity.

Exhibit 3 shows that e-commerce-related companies have experienced a challenging period since 2021. The index lost over 42% in the 12-month period ending July 31, 2022. From a country allocation perspective, 68% the index weight was allocated to companies in the U.S., and China had the second-highest weight at 17% (see Exhibit 4).

The recent drawdown was not unique to e-commerce companies; it prevailed in the growth sector. The S&P 500 Growth lost 28% in the first six months of 2022, and the Dow Jones Internet Composite Index lost 44% during the same period. Despite the performance headwind this year, e-commerce is not leaving our lives. In October 2021, Facebook announced its new endeavor into the Metaverse, which could introduce a new era for how people shop in the virtual world. The S&P Global E-Commerce Ecosystem Index is one possible way to track the evolution of e-commerce businesses in the long run.

1 Shiprocket, The History Of eCommerce & Its Evolution – A Timeline

2 UNITAD, How COVID-19 triggered the digital and e-commerce turning point

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

The Power of Style

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Craig Lazzara

Managing Director, Core Product Management

S&P Dow Jones Indices

At some risk of oversimplification, the 16.1% decline in the S&P 500® for the first eight months of 2022 can be divided into three intervals, as the market fell by 20.0% through June, rallied in July, and then resumed its decline in August. This story, of course, is still evolving: for all we now know, the market might continue to decline, penetrating its June lows. Alternatively, we might already be in the early stages of the next bull market. Some things, these among them, are knowable only well after the fact.

Exhibit 1 shows this year’s pattern of returns for the S&P 500, as well as for its Growth and Value components. When the market declined, Value outperformed, while Growth was the better-performing style in July’s rally. Neither of these behaviors is particularly surprising. Growth typically outperforms when the market rises, and Value when the market falls (although Value’s defensive credentials are much less impressive than those of such stalwarts as Low Volatility or Dividend Aristocrats®).

Although the direction of the style indices’ performance is unsurprising, the magnitude of the spread between their returns was remarkably large, as Exhibit 2 shows.

Taken over all six-month intervals in the history of our style indices, the 16.2% spread between Value and Growth in the first six months of the year was at the 97th percentile. The tables turned in July, as the spread was at the opposite extreme of all one-month intervals. Results in August looked like those from the first six months. (If we calibrate the Value-Growth spread in dispersion units, the results are even more extreme.)

Given the size of the spreads (both positive and negative) between Value and Growth indices, it’s reasonable to ask what impact value and growth scores had on the performance of other factors. We regularly score every stock in our database, and we therefore can compute aggregate value and growth scores for our most prominent factor indices. Exhibit 3 shows, for the first six months of 2022, the relationship between each factor index’s relative performance and the difference between its value and growth scores. Given the size of the Value-Growth spread in the first six months, the upward slope in Exhibit 3 is unsurprising.

Exhibit 4 shows that the relationship ran in the opposite direction in July, whereas in August we again see a strong upward-sloping relationship. The predictive power in both cases is impressive for a single month.

We said earlier that it was too soon to say whether the bear market that began in January was over or merely quiescent, and the same is true about the influence of style on returns. What seems reasonable to say is that if the differential performance of Value and Growth indices remains wide, the influence of style on other factors is likely to continue.

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

SPIVA Institutional and the Pharaohs of Finance

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Tim Edwards

Managing Director, Index Investment Strategy

S&P Dow Jones Indices

Ptolemy I (367 BC-282 BC), one-time companion of Alexander the Great and later pharaoh of Egypt, has an important role in intellectual history. Among other contributions, he is credited with founding the library at Alexandria, one of the seven wonders of the ancient world, and for personally sponsoring the work of Euclid, a mathematician whose Elements reigned for over 2,000 years as the definitive work on geometry. According to legend, Ptolemy found the textbook too complicated and requested an easier path to understanding, to which Euclid responded, “There is no royal road to geometry.”

S&P DJI’s regular SPIVA® Scorecards show that relatively few actively managed mutual funds deliver long-term outperformance, particularly in the equity markets and especially in large-cap U.S. equities. The implications of this result remain hotly disputed, especially by active managers. A common objection is that, at least for some princes, an easier path is available. A Ptolemaic fund selector would not simply make a random choice from all the funds available, instead sorting the wheat from the chaff by a robust selection process. Nor would they pay the fees typical of an average investor, instead benefiting from direct access, economies of scale and sharp negotiations.

The latest edition of the SPIVA Institutional Scorecard offers perspective on these topics, extending the data of the “classic” 2021 U.S. Scorecard to include the performance of institutional accounts and gross-of-fees performance. For an investor seeking to select outperforming funds, such data should be of particular interest; they reflect the chances of investors who are sufficiently resourced to conduct a careful search and a vigorous negotiation.

Exhibit 1 plots the 10-year underperformance rates reported in the Institutional Scorecard for 21 international and domestic U.S. equity categories for mutual funds (on the y axis) and institutional accounts (on the x axis), with gross- and net-of-fees underperformance rates represented by dots and triangles, respectively. The dark grey diagonal highlights an equal underperformance rate within both institutional accounts and mutual funds, and the two data points corresponding to the U.S. Large-Cap Equity category are highlighted for interest.

The chart illustrates several facts of increasing importance. First: the dots fall generally lower and to the left of the triangles, but not by much. In other words, gross-of-fee performance was better, but not by enough to change the overall conclusion. Second, most of the data points are above the diagonal line, implying generally higher underperformance rates among mutual funds than among institutional accounts, both before and after fees. Third, most of the data points are still quite close to the diagonal, implying that mutual fund and institutional account underperformance rates were broadly similar, no matter the equity category.

Finally, and most importantly, nearly all the data points in Exhibit 1 are in the top right quadrant. In other words, in most categories, more than 50% of actively managed mutual funds underperformed and more than 50% of actively managed institutional accounts underperformed. A careful search for a skilled manager and paying close attention to costs might improve the odds, but the long-term data suggest that even for the pharaohs of finance, there is no royal road to outperformance. 

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

Tucking in to the SPIVA Australia Mid-Year 2022 Scorecard

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Benedek Vörös

Director, Index Investment Strategy

S&P Dow Jones Indices

The semiannual S&P Indices Versus Active (SPIVA®) Scorecard1 measures the performance of actively managed funds against their corresponding benchmarks in various markets around the world. The latest Australian edition, the SPIVA Australia Mid-Year 2022 Scorecard, provides a number of interesting insights about the performance of active versus passive across active fund categories.

Although the long-term performance statistics remain grim reading for fund selectors, the first half of 2022 contained some bright spots for active managers: a slim majority of active Australian Equity General funds outperformed the S&P/ASX 200 in H1 2022. Ranging over time horizons and fund categories, we can see marked differences in the track records. Of active Australian international equity funds, 95% underperformed over the 15-year horizon, while domestic mid- and small-cap managers had greater success, with just over one-half of them underperforming the S&P/ASX Mid-Small over the same period. Large-cap domestic active managers landed in between, with 83% of active managers underperforming the S&P/ASX 200 in the past 15 years.

Digging deeper, underperforming funds tend to suffer withdrawals, which can lead to the affected funds’ eventual demise. Exhibit 2 shows survivorship rates of actively managed Australian funds across all categories over time. There is a strong downward-sloping trend, and in general, there was little divergence in the patterns of the decline of various fund categories; survivorship rates declined moving in near-lockstep across the board.

As Exhibit 3 shows, survivorship interacted with outperformance. In the Australian Equity Mid- and Small-Cap fund category, the majority of surviving funds outperformed the S&P/ASX Mid-Small, and even in the Australian large-cap segment, over one-third of surviving funds outperformed the S&P/ASX 200. However, the laws of natural selection did not seemingly apply to International Equity General funds, with almost 90% of surviving funds underperforming the S&P Developed Ex-Australia LargeMidCap.

Why might we see such differences between international and domestic equities? One reason may be that investors are more familiar with domestic than international performance standards; it may be easier for an Australian investor to judge the performance of domestic funds compared to international ones. This is not an issue limited to finance—they may also be better at judging surf than snow; they might also enthusiastically demolish a pizza that would bring a Neapolitan to tears.

While it can be challenging for a local investor to assess the performance of active managers, the semi-annual SPIVA Australia Scorecard brings transparent and objective assessments of international and domestic active fund performance, using industry-standard benchmarks that are recognized around the world. You can access the latest report here.

1See SPIVA Scorecards: An Overview. https://www.spglobal.com/spdji/en/education/article/spiva-scorecards-an-overview

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