IN THIS LIST

FA Talks: A Practitioner’s Guide to Accessing Next Gen Sectors with AI

TalkingPoints: Exploring Fixed Income in Africa

Understanding the S&P Managed Risk 2.0 Indices

TalkingPoints: S&P Leverage and Inverse Indices

TalkingPoints: Benchmarking Quality Small-Cap Equities in Brazil

FA Talks: A Practitioner’s Guide to Accessing Next Gen Sectors with AI

FA Talks is an interview series where industry thinkers share their thoughts and perspectives on a variety of market trends and themes impacting indexing.

How are financial advisors with an eye on the future using future-based tools to meet client goals today? 21st century sectors represent the foundation of the Fourth Industrial Revolution. The S&P Kensho New Economy Indices are designed to track emerging technologies that are reshaping traditional industries and driving this seismic shift. Lisa and Mark Bova of Lenity Financial see Financial Services as one of the industries at the forefront of these changes.

S&P DJI: How do you manage portfolios today at Lenity Financial?

Lisa: We utilize goals-based investing and use a tactical approach. One of the first questions we ask is about a client’s past experience with money, which includes long-term insights—meaning what they did or didn’t learn from their family. Based on their history, comfort level with risk, and their near-term needs and long-term goals, we work with our clients to determine their “risk budget,” which essentially defines how hard or not their money needs to work for them in order for them to reach their goals. Overall, we manage tactically. We can be overweight, underweight, or neutral on an asset class, segment of the market, or even risk. It all depends on the goals and risk budget of the individual client.

S&P DJI: Why was it important to you to find a passive solution using Artificial Intelligence to help meet clients’ needs?

Mark: In today’s markets, there is so much data and the market moves so quickly that we needed a way to effectively and efficiently process the constant stream of information. We were looking for a way to employ AI in our process and we found the S&P Kensho New Economy Indices. Kensho has a meaning—it is an initial insight or awakening. In what is believed by many to be the beginning of the Fourth Industrial Revolution, having the S&P Kensho New Economies in our toolkit made sense. We’re futurists and we see financial professionals working with machines as the way forward. Data is a critical component to AI. There has been so much data collected in the past several years, and S&P DJI has been one of the most pervasive providers of data for decades. Think of it, Henry Varnum Poor published An Investor’s Guide to the U.S. Railroad Industry in 1860. So, the ability to access the powerful combination of data and cutting-edge AI through the S&P Kensho New Economy Indices was a perfect fit for us.

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TalkingPoints: Exploring Fixed Income in Africa

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Zack Bezuidenhoudt

Director, Client Coverage Israel, Benelux, Nordics, and U.K.

S&P Dow Jones Indices

S&P Dow Jones Indices (S&P DJI) made a commitment in 2014 to expand its fixed income coverage to Africa. The index development process started with a series of sovereign bond indices designed to represent and measure performance within the region. The S&P Africa Sovereign Bond Index seeks to track the performance of local currency-denominated sovereign bonds from 13 countries within Africa. The index series also includes a benchmark of  hard currency bonds issued in U.S. dollars, euros, and Japanese  yen, as represented by the S&P Africa Hard Currency Sovereign  Bond Index.

As a subindex of the S&P Africa Sovereign Bond Index, the S&P South Africa Sovereign Bond Index is designed to track the performance of ZAR-denominated sovereign debt publicly issued by the South African government.

S&P DJI also developed the S&P South Africa Sovereign Inflation-Linked Bond Index, which is a subindex of the S&P Global Emerging Sovereign Inflation-Linked Bond Index.

    What details are available for these indices?

S&P DJI builds indices with transparency in mind. These indices aim to make opaque fixed income information more transparent by providing bond-level information in addition to the index-level performance measurements. Our reports are informative, insightful, and organized in order to provide efficiency, in addition to being a tool for investment performance measurement.

The S&P South Africa Sovereign Bond Index

The S&P South Africa Sovereign Bond Index seeks to track the performance of South African rand-denominated sovereign debt publicly issued by the government of South Africa in its domestic market.

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Understanding the S&P Managed Risk 2.0 Indices

SUMMARY

S&P Dow Jones Indices, in collaboration with Milliman, introduced the S&P Managed Risk 2.0 Indices, which seek to provide core equity strategies with an embedded risk management feature.  The key features of this strategy are the following.

  1. The cost of the protection embedded in the strategy is stable and is financed through a reserve asset, the S&P U.S. Treasury Bond Current 5-Year Index. During times when equity markets are under stress, the correlation effects between equities and the reserve asset class have historically provided a counterbalance through positive returns.  This is in contrast to strategies that use cash, which do not provide that benefit.
  2. Since protection is available, the strategy may provide the ability to participate more in the upside while keeping the overall risk at a low level. This shows up in the higher upside capture and similar or better downside capture than other risk management strategies.

Before diving into the details of the construction and performance of the strategy, it is helpful to consider why this strategy has been developed and the potential benefits it can provide.

FROM RISK CONTROL TO MANAGED RISK

Many readers may be familiar with risk control strategies.[1]  These strategies, which can use a single asset or multiple assets, dynamically adjust the exposure of a risky asset to target a predefined volatility level.  They became popular as a solution to reduce risk while retaining much of the gains to be had from “risky” assets like equities.

However, risk control strategies have some major limitations.They transform the distribution of investment outcomes in a linear and symmetric way, meaning that downside could be significant, although reduced, during severe and sustained market declines. 

Therefore, a number of managed risk strategies[2] have been created recently to improve the traditional risk control framework.  These strategies add an additional layer of risk management using a synthetic put hedge, seeking to stabilize volatility around a target level and, on top that, defend against losses during sustained market declines.

Note that this protection comes with a cost.  Although options on broad market indices are usually expensive, put option replication in the presence of volatility management tends to have lower and more stable performance costs. Therefore, these strategies enable more upside participation compared with the traditional risk control strategies. 

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TalkingPoints: S&P Leverage and Inverse Indices

  1. What are leverage and inverse indices and why are they important?

The S&P Leverage and Inverse Indices aim to replicate the daily performance of their underlying indices with a constant multiplicative factor, positive or negative, with or without embedded borrowing and lending costs. They offer market participants short-term trading tools for hedging and leveraging purposes. They also provide benchmarks for leverage and inverse products, such as leverage and inverse mutual funds, exchange-traded funds, exchange-traded notes, etc.

  1. What are the underlying securities of leverage and inverse indices?

The S&P Leverage and Inverse Indices can measure equities and futures indices. Examples of possible underlying equity indices would include the S&P 500® and the Dow Jones Industrial Average®.

The underlying futures indices could include equity futures indices, currency futures indices, commodity futures indices, and VIX® futures indices, such as  the Dow Jones Industrial Average Futures Index, S&P U.S. Dollar Futures Index,  S&P GSCI Crude Oil, and S&P 500 VIX Short-Term Futures Index.

  1. What return types are there for leverage and inverse indices?

For equity-based leverage and inverse indices, the index return types follow the underlying indices and can be measured in price return, total return, or net total return.

For futures-based leverage and inverse indices, both excess return indices and total return indices are calculated. The difference in excess return and total return is explained in question 4.

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TalkingPoints: Benchmarking Quality Small-Cap Equities in Brazil

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Silvia Kitchener

Director, Global Equity Indices, Latin America

S&P Dow Jones Indices

When it comes to small-cap equities, profitability matters. Over the past 25 years, the S&P SmallCap 600® has outperformed the Russell 2000 by almost 1.7% on an annual basis. A key driver of this outperformance was the quality bias that comes from the profitability screen that is built into the S&P SmallCap 600. What  happens when that same methodology is applied to small caps  in other markets? 

1. What are the characteristics of small-cap stocks and how have market participants used them traditionally?

An important characteristic of small-cap stocks is that they are considered growth stocks, because they have a higher potential for growth. Historically,  small caps have outperformed large caps over the long term. Studies have  shown that stocks with attractive price valuation and good growth prospects tend to outperform. Small-cap stocks also tend to be focused more domestically, offering a purer local play on Brazil growth. Furthermore, in smaller markets  like those in the Latin American region, small-cap indices can actually help develop the overall market by drawing attention to the smaller stocks, which may help create more demand for direct or indirect investment, either through individual stocks or through index-based strategies tracking small-cap indices.

2. The S&P/B3 SmallCap Select Index is part of a broader index series, the S&P Global SmallCap Select. What type of small-cap stocks do these indices track?

Small cap can be defined based on either a fixed market size or on a relative  size range, the latter being what we use in Brazil. We start with a broad view of  the market, with our country index taking into account all Brazilian companies that trade on B3 and meet the minimum size and liquidity criteria. We segment those by total market cap and then take the cumulative weight of the floatadjusted market cap to categorize the different segments. We use 70%, 15%, and 15%. The top 70% represents the large caps, the next 15% the mid caps,  and the bottom 15% the small caps.

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