Indexology^® Blog

As the bull market in U.S. equities continues, with the S&P 500^® up 18% YTD,¹ we have witnessed in parallel an extraordinary time in the fixed income markets. Historically low credit spreads have led to the outperformance of high yield bonds relative to corporate bonds and corporate bonds relative to Treasuries. The iBoxx USD High Yield Developed Markets outperformed the iBoxx $ Corporates by 2%, and the iBoxx $ Corporates outperformed the iBoxx $ Treasuries by 1% YTD.¹ Consistent with declining spreads, implied credit volatility has been muted. The CDX/Cboe NA Investment Grade 1-Month Volatility Index (VIXIG)² and CDX/Cboe NA High Yield 1-Month Volatility Index (VIXHY)² dipped below the 30 and 140 handles, respectively.

But what do these conditions mean for fixed income active managers? We analyze the traditional sources of excess return, one of which is taking on higher term or interest rate risk, as measured by the returns of longer-dated bonds relative to shorter-dated ones. Another source stems from dipping down the credit spectrum toward investment grade or high yield corporates. A final key driver of excess returns comes from greater exposure to illiquid bonds, estimated by the return differential between high yield and investment grade indices and their liquid counterparts.

As seen in Exhibit 2, a sharp reversal in the Term category’s excess returns from 2023 to 2024 meant that long duration tilts that would have rewarded managers in 2023 have hurt them so far this year. However, long-term high yield credit exposures continued to be accretive, with excess returns outpacing those of all other reported credit categories. In another reversal from last year, investors may have benefited from taking on illiquid exposures in the investment grade space.

Despite the availability of near-term opportunities to seek excess returns, most fixed income active managers have historically underperformed their benchmarks, particularly over longer horizons. In 2023, most Government funds underperformed across the yield curve. However, Investment Grade Intermediate and Investment Grade Short-Intermediate fund categories posted majority outperformance, as observed in Exhibit 3, perhaps benefiting from longer duration tilts outside the benchmark.

While interest rate, credit and liquidity conditions for the second half of 2024 remain unknown, we can look to history as a guide. Understanding the sources of fixed income excess returns over time may help explain the likelihood of outperformance within the bond markets. For more information across all our reported fixed income categories, please refer to the SPIVA U.S. Year-End 2023 Scorecard.

¹ Data as of July 11, 2024.

² The CDX/Cboe NA Investment Grade 1-Month Volatility Index measures the market’s expectation of the range of movement in the CDX North American Investment Grade Index five-year spreads over the next one month

² The CDX/Cboe NA High Yield 1-Month Volatility Index seeks to track the market’s expectation of the range of movement in the CDX North American High Yield Index five-year spreads over the next one month.

Momentum strategies, which tend to thrive in trending markets, have recently delivered strong performance due to continued economic strength and positive market sentiment. In the past 12 months, the S&P 500^® Momentum Index posted notable outperformance compared with some other S&P 500 factors, as well as the S&P 500 itself (see Exhibit 1).

In this blog, we will review the methodology, performance characteristics and attribution for the S&P Momentum Indices, with particular focus on the S&P 500 Momentum Index, S&P MidCap 400^® Momentum Index and S&P SmallCap 600^® Momentum Index.

Index Methodology

The S&P Momentum Indices generally use 12-month risk-adjusted price momentum to select stocks ranked in the top quintile (see Exhibit 2).¹ We skip the most recent month when calculating price momentum to account for short-term reversal effects.² The use of risk-adjusted momentum, instead of raw price momentum, can help to mitigate the negative effects of idiosyncratic risk associated with raw momentum and reduce downside risks.³

The constituents of the momentum indices are weighted by the product of their FMC and momentum score, subject to individual security and sector weight constraints. Such a weighting scheme strikes a balance between market exposure and target factor exposure. The indices are rebalanced semiannually, with a 20% buffer rule applied to reduce turnover.

A Short- and Long-Term View of Performance

Exhibit 3 illustrates that all three S&P Momentum Indices have historically outperformed their corresponding benchmarks based on absolute returns, both in the short and long term.

Over the past year, the S&P 500 Momentum Index, S&P MidCap 400 Momentum Index and S&P SmallCap 600 Momentum Index outperformed their benchmarks by 33.35%, 30.92%% and 16.49%, respectively.

Furthermore, these indices have demonstrated favorable capture ratios, delivering higher or similar returns during up markets ⁴ and experiencing smaller declines during down markets.

Top Performance Contributors

Exhibit 4 shows the top five contributors to the performance of these three S&P Momentum Indices over the one-year period ending June 30, 2024. Nvidia, Super Micro Computer and Abercrombie & Fitch were the top performers in the S&P 500 Momentum Index, S&P MidCap 400^® Momentum Index and S&P SmallCap 600^® Momentum Index, respectively.

Sector Exposure

Exhibit 5 shows the active sector weights for the S&P Momentum Indices. Over the full period, these indices have demonstrated minimal sector bets over time. Over the long term, compared to their respective benchmarks, the indices have had small overweights in the Information Technology, Health Care and Consumer Discretionary sectors, while also having modest underweights in the Financials and Materials sectors.

As of June 30, 2024, the S&P 500 Momentum Index had an active overweight of 18.40% in the Information Technology sector, while the S&P MidCap 400 Momentum Index and S&P SmallCap 600 Momentum Index had overweight positions of 15.89% and 14.77%, respectively, in the Industrials sector. Conversely, all three momentum indices had significant underweights in Financials.

Factor Exposure

Exhibit 6 provides insights into the factor exposure differences between S&P Momentum Indices and their respective benchmarks, utilizing Axioma Risk Model Factor Z-scores. As expected, the S&P Momentum Indices displayed significantly higher exposures to the momentum factor compared to their benchmarks. Furthermore, these indices exhibited higher quality, as evidenced by their higher profitability exposure and lower exposure to the leverage ratio. Lastly, the indices exhibited higher exposure to the growth factor and lower exposure to the value factor.

[1] Please refer to the S&P Momentum Indices Methodology for more details.

[2] Jegadeesh, Narasimhan and Sheridan Titman, “Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency,” The Journal of Finance, Vol. 48, No. 1, March 1993.

[3] Fan, Minyou, Kearney Fearghal, Youwei Li and Jiadong Liu, “Momentum and the Cross-section of Stock Volatility,” Journal of Economic Dynamics and Control, Volume 144, November 2022.

[4] The market is defined as the monthly performance of the underlying benchmarks from March 31, 1995, to May 31, 2024.

Last December, in a prior blog, we introduced the S&P 500^® High Dividend Growth Index, an innovative index that utilizes the S&P Global Dividend Forecasting Dataset to incorporate a forward-looking assessment when selecting constituents. The index is unique since it tracks companies in the S&P 500 that have not only consistently grown their dividends in the past, but also have the highest forecast dividend yield growth.

In this blog we will examine the index’s strong performance, with a particular emphasis on the short term given that the index was launched in Q4 2023. Furthermore, since the index’s methodology emphasizes a blend between high dividend yield and dividend growth, we will compare those metrics versus the S&P 500, in addition to providing a snapshot of current sector allocations.

Performance Summary

As Exhibit 1 shows, on a YTD and one-year basis, the S&P 500 High Dividend Growth Index has materially outperformed most dividend strategies by posting a 7.06% and 23.37% return over those time periods, respectively. Over the longer term, the index has kept pace with the S&P 500—no easy task as growth stocks have significantly outperformed value and dividend-oriented stocks over this time period.

The strong performance of this index may be attributed to its unique approach to dividend growth. By incorporating analysts’ forecasted dividend growth rates (which are partly based on fundamentals growth) in the selection and weighting process, the index may be being boosted by some of the growth factor’s strong performance over the short and long term.

Index Characteristics

Exhibit 2 displays the S&P 500 High Dividend Growth Index’s trailing 12-month dividend yield since April 2011. Over the full period, the index has averaged a 3% dividend yield, which is over 50% higher than the S&P 500 and S&P 500 Equal Weight Index. As of May 31, 2024, it’s trailing 12-month dividend yield was 3.43%, more than double the S&P 500’s yield of 1.35% and approximately 14% higher than its long-term average of 3%.

Exhibit 3 displays the annualized dividend growth rate for the respective indices since April 30, 2011. Over this period, the S&P 500 High Dividend Growth Index has grown its dividends by 10.65%, well above the S&P 500’s 8.82% dividend growth rate over that time. The combination of high current dividend yield plus high dividend growth is a result of selecting constituents with the highest forecasted dividend yield growth. By selecting based on dividend yield growth as opposed to dividend per share growth, the index has tended to provide a blend of both current yield and future dividend growth.

Exhibit 4 shows the sector weights of the S&P 500 High Dividend Growth Index as of May 31, 2024. Perhaps unsurprisingly for a dividend strategy, the Utilities sector possesses the highest weight at 23.7%, followed by the Financials and Real Estate sectors with 18.0% and 12.9%, respectively. The low weight of the Materials sector is likely due to its growth focus and the sector’s tendency to have less growth and more value exposure.

Conclusion

The S&P 500 High Dividend Growth Index has exhibited strong long-term performance and has recently outperformed both high dividend yield and high dividend growth strategies. In addition to strong performance, the index has historically provided a blend of current dividend yield plus dividend growth. The S&P 500 High Dividend Growth Index may serve as a tool to explore the potential applications of a dividend strategy that also incorporates a forward-looking assessment for constituent selection.

The S&P High Yield Dividend Aristocrats^® tracks companies that have grown their dividends for a period of at least 20 consecutive years, offering equity participation and the potential for enhanced dividend income.

Our recent blog highlights that the dividend growth rate for the S&P High Yield Dividend Aristocrats has exceeded inflation over the long term (2000-2023). In this blog, we extend this analysis to look at how the index has performed across past macroeconomic cycles. Our framework identifies four economic regimes that are determined by the strength and direction of both growth and inflation (see Exhibit 1).

Let’s now delve deeper into the performance data by examining the excess returns over the benchmark (S&P Composite 1500^®) as well as the total returns for each type of cyclical outcome (see Exhibits 4 and 5).

Periods of rising growth (as defined in Exhibit 1) have historically been in tandem with strong performance for equity markets (see Exhibit 4), with growth style stocks delivering outperformance. The “Goldilocks Zone”—the period of rising growth and falling inflation—is generally the period with highest excess returns versus the benchmark. However, dividend indices such as the S&P High Yield Dividend Aristocrats have a tilt toward value, and so there is a tendency for the index to underperform the benchmark in this environment. Regardless of the direction of inflationary pressure, in rising growth markets the average monthly S&P High Yield Dividend Aristocrats return has lagged the S&P Composite 1500 benchmark by 0.35%.

In periods of slowing growth when markets are falling, the downside protection characteristics of the S&P High Yield Dividend Aristocrats tend to be favorable. The index methodology encompasses strict dividend qualification criteria, which leads the index to track higher quality companies that may offer resilience at this time.

In a slowing growth but rising inflation backdrop, the S&P High Yield Dividend Aristocrats had a monthly average total return of 0.39%, which is around 120 bps of outperformance. Inflationary environments have historically tended to favor short-duration stocks such as Dividend Aristocrat companies. In slow growth periods where inflation is falling, the S&P High Yield Dividend Aristocrats’ performance has been in line with the benchmark.

The S&P High Yield Dividend Aristocrats has historically provided stable consistent long-term dividend growth and robust performance, with enhanced dividend yields. The index has traditionally participated on the upside but has shown defensive positioning in falling markets due to lower volatility.

¹ OECD CLI data https://data.oecd.org/leadind/composite-leading-indicator-cli.htm , OECD CPI data https://data.oecd.org/price/inflation-cpi.htm.

Not all dividend strategies are created equal. Discover how the S&P Dividend Aristocrat Indices screen for companies with a long track record of stable and increasing dividends to identify quality dividend growers and avoid the dreaded dividend trap.