Tag: Joe Nelesen

Categories
Equities

The Risk/Return Tradeoff: Results from the SPIVA South Africa Year-End 2022 Scorecard

The year 2022 was riddled with investment challenges worldwide, as fears of recession, rising inflation and geopolitical uncertainty ranked among a whirlwind of other market pressures. In South Africa, these risks manifested in two notably different halves of the year, with major equity and bond indices ending H1 in negative territory, but then rallying to recover in H2 (see Exhibit 1). The SPIVA® South Africa Year-End 2022 Scorecard assesses the aftermath and reveals how many active managers successfully navigated the 12-month rollercoaster of risk.

Although many actively managed South Africa Equity funds started the year strong—with only 36% underperforming the S&P South Africa 50 Index at the end of H1—most lost their advantage by the end of 2022, as 61% of South Africa Equity funds finished 2022 as underperformers relative to the benchmark (see Exhibit 2).

Our South Africa Scorecard (unusually) offers two comparison benchmarks for the domestic equity category, reflecting the differing opportunity set for foreign-investment-constrained fund managers versus those managers with fewer constraints. Consistent readers of SPIVA South Africa might observe that 2022 was the fifth year in a row that less than half of South Africa Equity managers underperformed the S&P South Africa Domestic Shareholder Weighted (DSW) Capped Index, but the eighth consecutive year in which more than half underperformed the S&P South Africa 50 Index. These differences emphasize the importance of benchmark selection in evaluating active performance. It is perhaps worth highlighting that, nonetheless, most active funds underperformed either benchmark over a 10-year horizon (see Exhibit 2).

The changing rate of underperformance from H1 to H2 seems to have mirrored similar changes in the challenge of stock selection: although 51% of stocks in the S&P South Africa 50 Index outperformed the index itself through the end of H1, by the end of the year, only 43% of stocks had a higher return than the index (see Exhibit 3).

Among other notable highlights from this year’s reports, Short-Term Bond funds caught the eye with a commendably low 12.5% underperformance rate. This was the fifth year in a row that 20% or fewer of Short-Term Bond fund managers underperformed the STeFI Composite on an absolute return basis. However, the dramatic increase in the underperformance rate to 83% using risk-adjusted returns suggests managers may be generating their outperformance from higher-risk securities.

Adding risk brought added return for some managers in 2022. Only time will tell whether such approaches result in persistent success in 2023 and beyond.

Categories
Factors

Momentum’s Mystique

I confess some superhero powers underwhelm me (really, Hawkeye, arrows?) or stretch credulity further than Hulk’s hyper-elastic jeans. However, one I can appreciate is Mystique, the shape-shifting mutant who constantly alters her appearance to stay one step ahead.

If factors were superheroes, I’d argue the S&P 500® Momentum Index (“Momentum”) and Mystique share commonalities, both misunderstood and powerful through constantly morphing into something new. As a reminder, the momentum factor refers to the tendency of outperforming stocks to continue outperforming in the near term.

Thirty years after the publication of perhaps the most cited paper on momentum, researchers continue exploring why it works. To some, the momentum premium is simply compensation for risk, while others attribute it to human behavioral biases such as loss-aversion or self-attribution. In other words, markets are made up of people who don’t always act rationally, and many don’t understand momentum. Let’s bust three common misperceptions about momentum using data from the S&P 500 Momentum Index (Mystique-blue in the charts below, naturally).

Myth 1: Momentum Is Just Risky or High Beta Stocks

While the S&P 500 High Beta Index (“High Beta”) selects the 100 highest beta stocks from the S&P 500, Momentum selects constituents with top-quintile risk-adjusted price return momentum scores. Resulting differences between High Beta and Momentum indices have historically led to only a 2% overlap and a -0.54 relative return three-year correlation. Performance also underscores the uniqueness of each factor. Just during January 2023, the performance of High Beta and Momentum differed by 17%—their fourth-highest spread since 2010.

Looking over a longer time horizon, data show an often inverse relationship between excess returns for High Beta and Momentum (see Exhibit 1).

Longer-term performance also highlights the differences (see Exhibit 2).

A keen eye finds that Momentum outperformed on a relative basis for the 2022 calendar year, perhaps busting the second part of Myth #1 that the factor is inherently higher risk. In reality, the S&P 500 Momentum Index selects stocks that rank highly on risk-adjusted performance, leading to an index with annualized risk that has historically been similar to or below that of the S&P 500 (see Exhibit 3).

If momentum indices can actually be constructed with similar or less volatility than the broader market, then we can begin addressing the second myth.

Myth 2: Momentum Only Works in Bull Markets

When the S&P 500 declined 18.1% in 2022, the S&P 500 Momentum Index outperformed, falling 10.5%. Curious about Momentum’s resilience, we examined its average excess performance during one-month periods when the S&P 500 was rising or falling. As seen in Exhibit 4, Momentum outperformed in both on average.

Clearly for momentum to work in different conditions, it must transform as the factor itself moves across different parts of the market. The most market-based among factors, Momentum has a historically high turnover, which leads to our final myth. 

Myth 3: The Momentum Factor Can’t Be Indexed.

Put differently, can indices continue to harness a factor like momentum through time? Affirmation comes from the fact that many “passive” indices (such as factors) are quite dynamic in how they rebalance.

Momentum “shapeshifts,” dramatically changing security and sector weights at rebalances to maintain high exposure to the targeted factor (see Exhibit 5).

Like Mystique taking on different forms, the S&P 500 Momentum Index is always changing by design, evolving in response to market conditions and maintaining a high exposure to the factor along the way.

 

 

Categories
Fixed Income

Tip of the Iceberg: Fixed Income ETFs in Times of Crisis

20 and 15 years after the launches of the first ETFs based on the iBoxx USD Liquid Investment Grade (IG) Index and iBoxx USD Liquid High Yield (HY) Index, respectively, ETFs are increasingly used to trade fixed income without the necessity of transacting individual bonds. The tradability of bond ETFs has been leveraged by a growing number of investors as market stressors regularly emerge, and crises have long offered proving grounds for index-based products, including ETFs. If the recent U.K. market downturn reminds us of anything (beyond the surprising resilience of a head of lettuce), it is that liquidity can be hard to find when it’s needed. As the Financial Times recently reported, the aftermath is forcing institutions to take a hard look at how quickly they can sell assets in a crisis.

One might wonder how such situations play out around the world when more ETFs and other index products are used as potential sources of liquidity. Indeed, each market crisis since the Global Financial Crisis has tested the idea that index-based bond ETFs could provide a buffer to be traded before resorting to selling underlying bonds. As seen in Exhibit 1, increasing volumes for ETFs tracking the iBoxx USD Liquid IG Index and iBoxx USD Liquid HY Index during periods of stress over the past 15 years has demonstrated that such funds and their underlying benchmarks may be tools that react quickly during volatile markets.

The increasing usage of ETFs based on the iBoxx USD Liquid HY Index, for example, is facilitated by the index methodology that emphasizes holding the most-traded bonds. Applying higher minimums to issuer size and amount outstanding while also capping single issuers, the index filters the USD 1.5 trillion developed iBoxx USD Liquid HY Index benchmark universe down to just over USD 1 trillion in highly traded components. The resulting index has historically supported not only ETFs but also an expanding ecosystem of other tradable instruments. For example, in 2021 the volume of futures and total return swaps connected to the iBoxx USD Liquid HY Index was nearly five times the same index’s ETF AUM (see “Income in Indexing: How the iBoxx Liquidity Ecosystem Lends Well to Credit Markets – Part 2”). High fund volumes and assets appear to have supported the growth of ETF options, as well as securities lending and portfolio trading.

Beyond the cornerstone iBoxx USD Liquid IG and HY Indices underlying ETFs at the core of a fixed income strategy, the proliferation of fixed income ETFs over the past decade (see Exhibit 2) could allow for even more fine-tuning of liquid-beta sleeves that mirror broader portfolio characteristics while remaining tradable intraday, potentially reducing pressure on asset owners to use their carefully selected bonds as a source of capital in a crisis.

In the end, index design matters. Done right, a fixed income index has the potential to harness the most-traded segments of the bond universe and support liquid instruments.

Categories
Equities

The Climb: SPIVA South Africa Mid-Year 2022 Scorecard

A clever (yet ill-fated) character once said, “Chaos is a ladder.” The first half of 2022 was indeed full of chaos in many major markets, including South Africa; our latest SPIVA South Africa Scorecard for the region shows where the rungs were slippery and where active funds were able to climb the fastest.

Overall, the underperformance rate of actively managed South Africa equity funds over H1 2022 was well below recent full-year measures (see Exhibit 1), with nearly two-thirds outperforming the S&P South Africa 50.

Avoiding a small number of underperforming stocks had the potential to make a big difference. Within the S&P South Africa 50, 49% of stocks trailed the benchmark and 51% outperformed, but just a few stocks contributed the majority of the index’s -6.3% H1 performance. Luxury goods firm Compagnie Financiere Richemont S.A (CFR) and communications company MTN Group Ltd. (MTN) combined to account for two-thirds of the total index decline. As the largest weight in the index, and the second-worst performer over H1, CFR made the most significant impact on the benchmark’s returns (see Exhibit 2).

Returns were not distributed “normally,” creating an interesting challenge for stock pickers. The median S&P South Africa 50 stock return was -5.1% in H1, close to the index return, but the (unweighted) average stock return was 0.3%, due to the strong outperformance from a minority of large winners. Indeed, the outperformers averaged 23% excess return, while underperformers returned -11% on average. Even when excluding an outlier with more than 200% excess return during H1 (and a weight in the index of less than 1%), the average excess return of remaining outperformers was 16%. In other words: a manager’s chances of picking an underperforming or outperforming stock were nearly equal, but outperforming stocks were disproportionately rewarding to performance.

Based on the relative performance of the S&P South Africa 50 Equal Weight Index, tilting away from mega-cap names may have been one way for active managers to navigate a successful H1. The equal-weighted index outperformed the cap-weighted S&P South Africa 50 by 1.5% through H1, and in a perhaps positive sign for the full-year results, has continued to separate itself by an even wider margin since then (see Exhibit 4).

Reducing weights of the largest stocks in the benchmark remains a prevalent active management strategy, and one that may have benefited active managers in South Africa in the first half of 2022. So how did active managers do on a risk-adjusted basis? To find out, you’ll have to dive deeper into the SPIVA South Africa Mid-Year 2022 Scorecard. (Spoiler alert: some results are very different!)