Indexology^® Blog

Anyone who has perused our S&P 500^® Factor Dashboard for December 2022 (and it’s a shame if you have not) will recognize Exhibit 1 below. The horizontal axis represents the difference between the weighted average value and growth scores (at the beginning of 2022) for each of the 17 factor indices in our dashboard, while the vertical axis shows each index’s 2022 performance relative to the S&P 500.

Exhibit 1 shows that the value-growth differential explained nearly 80% of the variation in performance across factor indices last year. The importance of style exposures in explaining factor index returns is unsurprising given the significant spread between Value and Growth returns in 2022. S&P 500 Value outperformed S&P 500 Growth by 24% last year, Value’s biggest winning margin since 2000, and the fourth highest since 1995.

Style scores are not the only potential explanatory variable; sector exposures can also be relevant in analyzing relative returns. Information Technology, the largest sector in the S&P 500, underperformed the benchmark by 28% in 2022, and Exhibit 2 shows the relationship between each factor index’s IT weight and its relative performance. This simple metric has even more predictive power than the spread between an index’s value and growth scores.

But sector and style exposures are not independent. In 2022, IT was the sector most underweighted in S&P 500 Value and most overweighted in S&P 500 Growth. Alternatively, of the S&P 500’s 11 sectors, IT had both the lowest weighted average value score and the highest weighted average growth score. This raises an obvious question: did IT underperform because it was expensive and fast-growing, or did Value outperform (and Growth underperform) because of their IT weightings?

We can address this question by ranking the S&P 500’s constituents by the difference between their value and growth scores, and then dividing the index into quintiles. Consider the quintile with the biggest difference between value and growth scores, a combination of cheapness and relatively slow growth. IT composed 7.4% of the weight of this quintile, and those issues represented 5.0% of the weight of the IT sector. Between 7.4% and 5.0%, there’s not much to choose.

At the opposite end of the scale—the “expensive, fast growth” or “EFG” quintile—there is a much bigger distinction. Exhibit 3 shows that IT companies represented 81% of the EFG quintile’s weight. The same “expensive, fast growth” companies made up 64% of the IT sector. In other words, the IT sector had much more exposure to non-EFG names than the EFG quintile had to companies from sectors other than IT.

On this basis, it’s fair to say that IT was more important to the expensive, fast growth quintile than members of that quintile were to the IT sector. This is a particular result rather than a general observation. At other times and with other sectors and factors, the conclusion might well be different. But in 2022, it appears that the IT sector was more important to the interplay of value and growth than that interplay was to IT.

What’s driving the rise of passive investing? Take a deep dive into the active vs. passive debate as S&P DJI’s Craig Lazzara explores what two decades of SPIVA has to say about why active has historically tended to underperform passive around the world.

The S&P 500^® Equal Weight Index launched on Jan. 8, 2003, so Sunday marked 20 years since the index first allowed investors to measure the performance of egalitarian allocations among S&P 500 constituents. The index is now tracked by various investment products globally, and it has potential benchmarking applications. Exhibit 1 shows that the S&P 500 Equal Weight Index has outperformed the S&P 500, both since January 2003 and when observing its back-tested history starting in the 1970s.

Arguably the biggest driver of the S&P 500 Equal Weight Index’s outperformance was its smaller size exposure. Having more (less) exposure to the smaller (larger) names in the S&P 500 explained over 50% of the S&P 500 Equal Weight Index’s relative returns, historically, and it was useful when exploring equal weight’s impact on risk/return. Indeed, it helped to explain the case for equal weight indexing amid the elevated concentration in S&P 500 constituents in recent years. Exhibit 2 illustrates the historical dynamic between changes in concentration and the relative performance of the equal weight index.

However, size exposure was far from the only source of outperformance in equal weight indices. For example, the S&P 500 Equal Weight Index’s anti-momentum and value factor tilts, along with its distinct sector exposures, helped it to beat the S&P 500 by 7% in 2022. More strategically, the equal weight index benefited from positively skewed equity returns: Exhibit 3 shows that for an average calendar year between 2003 and 2022, the index offered more exposure to the best-performing S&P 500 stocks.

In addition to the potential relevance of the S&P 500 Equal Weight Index to those looking for large-cap U.S. equity exposure, there are several reasons why investors may wish to use the S&P 500 Equal Weight Index as a supplemental benchmark for large-cap U.S. equity managers. For example, the equal weight index may be a more suitable benchmark, given that it appears many active managers have historically been closer to equal weighting than cap weighting in their portfolio construction. Exhibit 4 illustrates that the S&P 500 Equal Weight Index set a higher standard for large-cap U.S. equity active managers to beat over various horizons ending June 30, 2022.

The S&P 500 Equal Weight Index’s 20^th birthday offers a chance to reflect on its performance, characteristics and potential use cases. Here’s to the next 20 years!

“Never sell the bear’s skin before one has killed the beast.”

Jean de La Fontaine.

On Wall Street, bear markets represent declines of at least 20% from their highs. But on Main Street, bears are anthropomorphized as friendly. Here we look at whether bears can also be “friendly” in financial markets, looking at the S&P 500^®’s bear markets to assess what periods of pessimism have told us, historically, and whether there may be glimmers of hope.

A tumultuous 2022 resulted in the S&P 500 entering a bear market and posting its worst calendar year performance since 2008, down 18%, bringing an end to its three-year winning streak. The picture could have been grimmer had it not been for an early rally  in October and November; the S&P 500 was down more than 25% at its worst point.  Exhibit 1 shows that the S&P 500’s reached only one all-time high during 2022 (on Jan. 3), the fewest all-time highs in a year since 2012.

Investors may be forgiven for forgetting what it feels like to be in a bear market. The S&P 500’s longest bull market, which began after 2008’s Global Financial Crisis (GFC), was followed by the shortest bear market in history. Exhibit 3 shows that the current 2022-23 bear market’s 20% decline hasn’t reached the same magnitude as the 2020 COVID-19 sell-off or 2008 GFC, which recorded declines of 34% and 57%, respectively. However, 2022’s bear market is already 11 times the length of 2020’s COVID correction.

Overall, the S&P 500’s 14 bear markets since 1928 lasted an average of 19 months and were accompanied by an average peak-to-trough performance of -38% (see Exhibit 3).

However, market participants can take one silver lining from history—the S&P 500 has typically rebounded from major drops over medium horizons. For example, Exhibit 4 shows that the S&P 500 gained an average of 15% over the three-year period following the beginning of a bear market, and the index typically exhibited a positive return. While history shows the importance of treading with caution in bear markets, a friendly reminder is that at the end of every bear market, a bull market begins and all things pass in time.

2022 was a difficult year for equity investors as rising interest rates, increasing geopolitical risks and slowing economic growth put downward pressure on equities. However, factors such as dividend yield and value fared much better than the broader equity market due to their shorter durations.  Despite this challenging economic environment, the S&P 900 Dividend Revenue-Weighted Index posted an impressive 7.57% in 2022, representing 25.39% outperformance versus its benchmark. In this blog, we will analyze this index’s methodology and examine the dividend yield and value tilts, all of which contributed to its outperformance.

Methodology Overview

To avoid value traps, the methodology begins by excluding the top 5% of stocks based on: (1) the average 12-month trailing dividend yield in the universe; and (2) the last 12-month dividend payout ratio in a GICS^® sector. Additionally, only stocks that currently pay a dividend and have had positive revenue over the last 12 months are eligible.

Next, the index selects the top 60 stocks with the highest dividend yield within the eligible universe. These constituents are then weighted by their revenue for the trailing four quarters, with an individual constituent weight cap of 5%. This fundamental weighting approach, rather than a market-cap approach, gives the index a value tilt.

Historical Impact of Dividends on Total Return

Exhibit 2 shows the performance from June 30, 2003, to Dec. 31, 2022. Over this period, the S&P 900 Dividend Revenue-Weighted Index posted a total return of 540.75% and a price return of 159.35%. Over the same period, the S&P 900 generated a total return of 489.32% and a price return of 303.49%.

As of Dec. 31, 2022, the S&P 900 Dividend Revenue-Weighted Index’s trailing one-year dividend yield was 3.99%, versus 1.74% for the S&P 900. Such dividend yield advantage, compounded and reinvested over many years, is a key determinant for the long-term total return outperformance of the S&P 900 Dividend Revenue-Weighted Index compared with its benchmark.

Historical Performance in High-Inflation Environments

Given the current inflationary environment, it is important to understand how the S&P 900 Dividend Revenue-Weighted Index has historically performed relative to its benchmark in similar economic climates. High-inflation periods are defined as at least 10 consecutive months where the year-over-year CPI rate exceeds 3%. Exhibit 3 shows that the S&P 900 Dividend Revenue-Weighted Index outperformed its benchmark in all four recent inflationary environments.

Sector Composition

Over the long term, Exhibit 4 shows that the S&P 900 Dividend Revenue-Weighted Index was overweight in the Utilities and Communication Services sectors (driven by the Telecommunication Services and Media industries) and underweight in Information Technology, Industrials and Health Care.

Factor Exposure

From a long-term factor perspective, the S&P 900 Dividend Revenue-Weighted Index has demonstrated a value tilt, as shown in Exhibit 5. Using Axioma Risk Model Factor Z-scores from June 30, 2003, to Dec. 31, 2022, the S&P 900 Dividend Revenue-Weighted Index had higher exposure to the book-to-price and dividend yield factors, similar exposure to earnings yield and lower exposure to growth factors such as sales and earnings growth when compared with the S&P 900.

Conclusion

The S&P 900 Dividend Revenue-Weighted Index has demonstrated solid outperformance over the long term, as well as in previous and current inflationary environments. Additionally, its emphasis on dividend yield and value could offer investors more protection against rising interest rates relative to its benchmark. For market participants who believe that the current economic environment may persist, the S&P 900 Dividend Revenue-Weighted Index might be an option worth considering.