Indexology^® Blog

Cryptocurrencies were designed to be decentralized and borderless, and different regions have different rates of adoption and use. In Asia, a new report by Accenture titled “Digital assets: Unclaimed territory in Asia”¹ reported that 52% of affluent investors held digital assets as of Q1 2022, and the percentage was expected to rise to 73% by year-end 2022. The report also noted that over 80% of Singapore’s market participants demonstrated a strong interest in digital assets.

According to a recent article in the Wall Street Journal,² Singapore’s status as a crypto hub grew when its rival, Hong Kong, lost some appeal when China cracked down on crypto trading and mining in 2021. Many established firms quickly relocated to Singapore.

With crypto innovation and investor interest plus excitement around the upcoming Token2049 Singapore conference in September 2022, we see Asia—and Singapore specifically—shine as a crypto hub. To that end, we are preparing to launch new indices specifically designed for the APAC market.

The first wave of the launch will include two indices:

• S&P Cryptocurrency Top 10 Index (Singapore Close) (USD)
• S&P Cryptocurrency Top 10 Dynamic Rebalancing Risk Control 40% Index (Singapore Close) (USD)

S&P DJI’s independent indices have a long track record of bringing transparency to a wide range of markets across asset classes and geographies, and we believe they can do the same for this emerging asset class in Asia.

The first index, S&P Cryptocurrency Top 10 Index (Singapore Close), is designed to measure the performance of the largest 10 cryptocurrencies by market capitalization.³ It uses a 9PM Singapore close to capture trading in the Asian market. Just as the stocks in the S&P 500^® make up about 80% of the total U.S. equity market cap, this new index represents approximately 85% of the S&P Cryptocurrency Broad Digital Market (BDM) Index as of September 2022.

One feature of this index is a custodian screen, which may enhance investability by requiring all coins to be held by at least two institutional-grade custodians. A custodian screen helps address the many challenges of cryptocurrency custody. We have touched on some of these issues in an earlier blog. As part of the index methodology, each constituent coin must be covered by a minimum of two custodians that demonstrate both appropriate technology security—either multi-party computing (MPC) or Multi-Sig—and information security standards, as defined by SOC II or ISO27001. Appropriate custody makes it easier for asset managers to hold and invest in the coins.

For those looking to mitigate volatility in the cryptocurrency market, we are also providing a risk control feature for this index: the S&P Cryptocurrency Top 10 Dynamic Rebalancing Risk Control 40% Index. This new index seeks to limit the volatility of the underlying S&P Cryptocurrency Index to a target level of 40% by adjusting the exposure to the underlying index and allocating to U.S. dollars. The index is rebalanced on a dynamic basis; that is, when the 10% threshold based on exposure is crossed (S&P Risk Control Indices are also available for traditional asset classes—equities, commodities and more).

For S&P DJI, these new indices represent one more way to bring transparency and leadership to this emerging asset class.

For additional details, please refer to S&P Digital Market Indices Methodology, S&P Risk Control Indices Methodology & Parameters for current parameters, and to the S&P Risk Control Indices section of the S&P DJI Index Mathematics Methodology.

¹ Accenture Wealth Management, “Digital assets: Unclaimed territory,” 2022, p. 4.

² Yu, Elaine and Caitlin Ostroff, “Crypto’s Collapse Deals New Challenge for Regulators in Singapore,” Wall Street Journal, Aug. 11, 2022.

³ Market capitalization corresponds to coin supply multiplied by coin price for cryptocurrencies.

I am not a particularly good athlete, and perhaps the sport at which I am most inept is basketball. Despite that, let’s assume that I somehow challenge Michael Jordan, arguably the best player in the history of the game, to a free throw shooting contest. What are my chances of success? (Stay with me, I promise there’s a non-trivial point here.)

Obviously, the answer depends on how good each of us is. Michael Jordan made 83.5% of his foul shots during his NBA career, so I’m going to be generous and assume that he’s just as good now as he was during his playing days. I’m going to be even more generous to myself, and assume that I can make 20% of my free throw attempts. Obviously, Michael has a considerable advantage in terms of skill. But chance also plays a role.

For example, I might make my first shot (20% probability), and he might miss his first one (16.5% probability). So the probability that I will be ahead after one round is 3.3% (0.20 x 0.165). Alternatively, we might both make our shots (16.7% probability) or we might both miss (13.2% probability). The only way that Michael can be unambiguously ahead of me after one round is if he makes his shot and I miss mine. Of course, that’s the most likely outcome, with a probability of 66.8%.

But if this imaginary contest happened in real life, after one round the likelihood that I would be holding my own against Michael Jordan would be 33.2%, which I would count as the greatest athletic accomplishment of my life (even better than the freak hole-in-one last summer).

Of course, reality would ultimately intrude; the contest doesn’t end after just one round. There are four possible outcomes after the first round, 16 after two rounds, and 64 after three rounds. Exhibit 1 shows how the likelihood of my success shrinks over time.

The moral of the story is that the low-skill player looks better when there are fewer trials and luck can play a bigger role. Over short periods of time, luck can dominate skill. On the other hand, the high-skill player benefits from more trials, since his higher level of skill is likely to overcome any bad luck that may come his way.

Why is this relevant to an index blog? Because in the investment world, one analogy to shooting multiple rounds of free throws is observing longer periods of active versus passive performance. We have begun to issue our semiannual SPIVA^® scorecards, with reports so far available for Australia, the U.S., Europe and Canada. Exhibit 2 summarizes some of the results.

Here, the active managers in each market assume the role formerly played by me, and the benchmarks take over for Michael Jordan. But the moral of the story is the same: more observations reduce the importance of luck. Active managers typically look worse as the observation period lengthens; the good luck from which some benefit over a short period tends to dissipate as more time goes by.

In actual investment experience as in hypothetical basketball, skill persists, but luck is ephemeral.

This blog was co-authored by Smadar Shulman and Paulina Lichwa-Garcia.

As the transition to net zero is becoming a critical consideration in portfolio management, the popularity of indices that incorporate the EU’s minimum standards for Climate Transition Benchmarks (CTBs) and Paris-aligned Benchmarks (PABs) has been gathering pace. Such benchmarks aim to select securities that are collectively compatible with a lower carbon economy.

What Are EU PABs and CTBs?

The EU has defined a regulatory framework with minimum standards for benchmarks labeled PAB and CTB¹ in line with the goals of the Paris Agreement and net zero by 2050. These are similar in their year-on-year decarbonization trajectories but differ in the greenhouse gas (GHG) emissions reductions and business activity exclusions. Exhibit 1 illustrates their similarities and differences.

Application of the S&P PACT™ to Fixed Income indices

While the blueprint regulation provides minimum standards, there are additional elements relevant for fixed income investors to consider. This includes methodology design, application to a fixed income universe and further consideration of climate-related risk factors.

The recently launched iBoxx EUR Corporates Net Zero 2050 Paris-Aligned ESG expands the suite of S&P PACT Indices (S&P Paris-Aligned & Climate Transition Indices) into fixed income. The index is based on the broad iBoxx € Corporates, covering investment grade euro-denominated corporate bonds, and takes into consideration not only the EU minimum standards for PABs, but also other factors such as transition risk, climate opportunities, ESG score overlay and fixed income risk and return profiling constraints.

The iBoxx EUR Corporates Net Zero 2050 Paris-Aligned ESG offers a differentiated solution for fixed income investors seeking a bond benchmark that incorporates the goals of the Paris Agreement that:

• Aims to meet or exceed the EU’s minimum standards for PABs;
• Leverages multiple ESG data sources, utilizing screening and optimization to determine climate index constituents and weights;
• Incorporates factors that seek to manage transition risk and climate change opportunities, in alignment with the recommendations of the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD);
• Offers a broad exposure while aiming to efficiently track the underlying index (iBoxx € Corporates) and minimize turnover; and
• Improves the ESG score against the underlying universe.

In addition to the required decarbonization trajectory (using Scopes 1, 2 and 3 GHG emissions data) and a minimum set of exclusions, the index also excludes companies involved in fossil fuel operations and power generation. Furthermore, the index seeks to reduce companies’ fossil fuel reserves emissions exposure versus the underlying index, which is considered a more forward-looking measure than historical GHG emissions. Both transition risks are based on S&P Global Trucost ESG and climate data. The ESG overlay exceeds the EU’s minimum standards by aiming for ESG score² improvement against its underlying index universe.

Going beyond the EU’s minimum standards, the index also aims to track the underlying index efficiently by design, minimizing turnover and including fixed income constraints (e.g., on yield, duration, maturity and rating).

In terms of climate opportunities, the index apportions a higher weight to green bonds,³ reflecting the opportunity embedded in such issuance.

Index Profile: iBoxx EUR Corporates Net Zero 2050 Paris-Aligned ESG

Comparing the iBoxx EUR Corporates Net Zero 2050 Paris-Aligned ESG with its underlying index, Exhibit 3 illustrates the sustainability-related improvements.

Going deeper, Exhibit 4 shows a comparison of key metrics and breakdowns by sector, maturity and rating.

Conclusion

At the core, the iBoxx EUR Corporates Net Zero 2050 Paris-Aligned ESG has a simple goal of providing an indexing solution for products seeking to divert capital into investments aligned with the net zero 2050 pathway. But as a solution to a complex problem, it incorporates multi-layer considerations in a rules-based way. The iBoxx EUR Corporates Net Zero 2050 Paris-Aligned ESG seeks to achieve and exceed the EU’s minimum standards while also building in considerations for ESG, climate risk-related factors and fixed income-related risk/return profiling while closely tracking the underlying benchmark.

¹ Regulation (EU) 2019/2089 of the European Parliament and of the Council of 27 November 2019 amending Regulation (EU) 2016/1011 as regards EU Climate Transition Benchmarks. EU Paris-aligned Benchmarks and sustainability-related disclosures for benchmarks. https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32019R2089&from=EN

² ESG score is sourced from Sustainalytics research.

³ These are broadly based on the International Capital Market Association’s (ICMA) voluntary Green Bond Principles, which require a Use of Proceeds (UoP) commitment for green projects: https://www.icmagroup.org/sustainable-finance/the-principles-guidelines-and-handbooks/green-bond-principles-gbp/

U.S. dollar strength has led to parity in EUR-USD exchange rates in recent days, with the value of the euro equaling 99 U.S. pennies at its low. While 114 U.S. pennies were still required to equal the British pound sterling, “cable”—the GBP-USD rate—has reached its lowest since 1985.

In Asia, the Japanese yen has suffered the most YTD of any developed market currencies versus the U.S. dollar. Meanwhile, the Chinese yuan has surpassed 7 to the U.S. dollar, while the Brazilian real gained in contrast.

Year-to-date, the Dow Jones FXCM Dollar Index, which measures the U.S. dollar versus the most liquid currencies, was up 9.03%, capturing the general trend in U.S. dollar strength.

For U.S. investors holding equities from these markets, this means returns of these holdings have decreased when translated back into a stronger U.S. dollar, compounding the weak underlying market performance. To estimate the impact of this broad currency weakness versus the U.S. dollar, Exhibit 2 shows country index returns in both U.S. dollar and the local currency (LCL).

In aggregate, developed market indices have been most affected, with the performance relative to the local currency return decreasing by more than 11% YTD. Meanwhile, currency losses were more mitigated across emerging markets, in part due to the offsetting gains in the Brazilian real.

Exchange rate moves can have a meaningful impact on international equity performance. While recent global market performance has been weak, U.S. investors have been doubly affected by currency underperformance versus the U.S. dollar. If the current trend reverses, a weakening U.S. dollar would become additive to international equity returns for these investors.

Those who implement style investing will have noticed a recent reversal of fortunes for the value approach following a long spell of underperformance. Since the inception of the S&P/ASX 200 Growth and S&P/ASX 200 Value in 2017, the back-tested approach has seen growth top value in 12 out of the past 17 calendar years.

However, with growth peaking in Australia and broadly across developed markets in 2020 (2021 in the U.S.), the rotation toward value is well underway. The digital innovation-led market with a prolonged period of loose monetary policy has given way to high inflation—now reaching multiple decade highs and tightening monetary policies by central banks. In this environment, future company earnings are discounted more heavily, and they are exposed to higher capital and other input costs, which hinders growth.

Value outperformed growth in 2021 across the board in developed markets. In Australia, value trumped growth by more than 7% and has accelerated its resurgence in 2022, outperforming growth by over 10% YTD and by more than 20% cumulatively over the past two years (as of Aug. 31, 2022).

Over the one-year period as of Aug. 31, 2022, value exhibited resilience in a falling market, with the S&P/ASX 200 Growth (-9.19%) and the broad market S&P/ASX 200 (-3.43%) declining, while the S&P/ASX 200 Value gained 2.64%. An outperformance spread of nearly 12%.

The S&P/ASX 200 Growth and S&P/ASX 200 Value consist of companies with pure growth and value characteristics, respectively, as well as companies within the broader S&P/ASX 200 categorized as “blend.” This style bias results in two distinctive indices from companies within the S&P/ASX 200. Exhibit 4 highlights the difference in sector weights between the value and growth approaches.¹

In the current market environment, we can see significant dispersion of returns among sectors, with the one-year difference as of Aug. 31, 2022, between the highest-performing sector (Energy 53.00%) versus the worst-performing sector (Information Technology -34.75%) at 87.75%. This spread is among the highest exhibited over one-year periods going back 10 years. The past 12 months have seen the outperformance of Energy over Materials, Consumer Staples over Consumer Discretionary and Financials over Health Care, and it has resulted in considerable relative gains for the value approach over the broad market.

As expected, the correlation between the growth and value investment styles has significantly lowered compared with longer-term averages. This also rings true in global markets, with value and growth indices in the U.S., Europe and Japan displaying similar dynamics over recent months—a value-led comeback, higher sector dispersion and lower correlation following a long period of growth outperformance.

Australian investors haven’t historically been as style aware with their domestic equity exposure compared to those in the U.S. and other developed markets. Given such distinctive performance characteristics, the S&P/ASX 200 Growth and S&P/ASX 200 Value offer a unique lens through which to evaluate market dynamics compared to the broad market S&P/ASX 200.

¹ Please refer to the methodology document for S&P/ASX Indices for more information: https://www.spglobal.com/spdji/en/documents/methodologies/methodology-sp-asx-200-style.pdf.