IN THIS LIST

An Index Approach to Factor Investing in India

A Case for Dividend Growth Strategies

The Relevance of U.S. Equities to Latin America

Concentration within Sectors and Its Implications for Equal Weighting

How the Proposed Consultation on GICS Structure Changes May Affect the S&P Carbon Efficient Indices

An Index Approach to Factor Investing in India

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Jason Ye

Director, Factors and Thematics Indices

S&P Dow Jones Indices

Introduction

Interest in factor investment solutions have significantly risen in the past decade.  In general, factor investing refers to an approach that targets stock characteristics that drive the difference in expected returns over the long term.  Sometimes, factor investing is referred to as smart beta, or strategic beta, because the factor approach will deviate the underlying portfolio from the market portfolio (the market beta) in a systematic method.  Some of the common factors that have been well documented in academic literature and adopted by the investment industry include low volatility, momentum, quality and value. Most of the evidence has been strong and promising that those factors can generate excess returns over the historical sample periods.  As of March 31, 2022, factor ETFs managed about USD 1.6 trillion assets globally, a 24.6% CAGR compared with the USD 178 billion 10 years ago.

How did these factors perform in the Indian market?  Can investors access factor performance through an indexing approach?  What are some applications of factor indices in the Indian market?  In this paper, we introduce the S&P BSE Factor Index Series, which implements the factor investing framework through an indexing approach to reflect the performance of the low volatility, momentum, quality and value factors.

In the following four sections, we provide brief descriptions of the S&P Dow Jones Indices (S&P DJI) approach to each of the common factors.  We will then provide an extensive discussion on the performance of the four factor indices, and a potential approach to combining the four factor indices to form an alternative for core equity allocation.

In each of the introductory sections, we follow the same framework to present the factors.  The underlying index universe to construct the S&P BSE Factor Index Series is the S&P BSE LargeMidCap, which is designed to represent the top 85% of the total market cap of the S&P BSE AllCap.  The S&P BSE LargeMidCap was launched in 2015, with the first value available in September 2005, so we use back-tested historical data starting on Sept. 30, 2005, to study the full sample period performance of each factor.  Every six months, at month-end in March and September, we sort the constituents of the S&P BSE LargeMidCap in order by each factor.  We then form equal-weighted quintiles and market-cap-weighted quintiles from those sorted values, denoting Quintile 1 as the stocks with the highest exposure to the factor and Quintile 5 as the stocks with the lowest exposure.  We are interested in whether Quintile 1 generates better performance than Quintile 5.  The performance of Quintile 1 tends to be more important, especially for long-only investors.  We analyze the performance from both the annualized compound return and the risk-adjusted return perspectives.

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A Case for Dividend Growth Strategies

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Izzy Wang

Senior Analyst, Factors and Dividends

S&P Dow Jones Indices

Dividend strategies have gained a foothold with market participants seeking potential outperformance and attractive yields, especially in the low-rate environment since the 2008 Global Financial Crisis and the even lower-rate environment we have seen since 2020, as the world deals with the economic fallout from COVID-19.  Entering 2022 with continuing global economic uncertainties, geopolitical disputes, high inflation and rising rates, a dividend growth strategy focusing on dividend sustainability and financial quality remains attractive.

With the volatile economic situation that has emerged since 2020, and market uncertainties putting pressure on corporate earnings, high-yielding companies without strong financial strength and discipline may not be able to sustain future payout and could be prone to dividend cuts and suspensions.

Stocks with a history of dividend growth, on the other hand, could present a compelling investment opportunity in an uncertain environment.  An allocation to companies that have sustainable and growing dividends may provide exposure to high-quality stocks and greater income over time, therefore buffering against market volatility and addressing the risk of rising rates to some extent.

This argument goes beyond the traditional realm of domestic large-cap stocks.  It also works for small- and mid-cap stocks and can be applied to international markets as well.

The S&P High Yield Dividend Aristocrats® is designed to track a basket of stocks from the S&P Composite 1500® that have consistently increased their dividends every year for at least 20 years.  This paper investigates the benefits of a dividend growth strategy by analyzing the characteristics of the S&P High Yield Dividend Aristocrats and comparing it to the S&P 500® High Dividend Index—a high-dividend strategy built on the S&P 500 (see the Appendix for an overview of the index’s methodology).  In addition, this paper illustrates a few indices that focus on the strongest dividend growers in global and international markets, including Canada, the eurozone, the U.K., Pan Asia and Japan.

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The Relevance of U.S. Equities to Latin America

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Hamish Preston

Head of U.S. Equities

S&P Dow Jones Indices

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María Sánchez

Director, Sustainability Index Product Management, U.S. Equity Indices

S&P Dow Jones Indices

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Fei Wang

Senior Analyst, U.S. Equity Indices

S&P Dow Jones Indices

It is common for equity investors to overweight their home countries relative to the global opportunity set. Such a "home bias" means that many investors may be underallocated to U.S. equities, which accounted for 59% of global equity float market capitalization as of the end of 2021. In this paper, we:

- Highlight the relative size of the U.S. equity market, including mid- and small-cap companies;

- Demonstrate how incorporating U.S. equities can diversify domestic sector biases, provide exposure to U.S. economic growth and potentially improve risk-adjusted returns (see Exhibit 1);

- Introduce the S&P 500®, S&P MidCap 400® and S&P SmallCap 600®, collectively known as the S&P Composite 1500®; and

- Show how active managers have found it difficult to outperform index benchmarks, historically.

The Relevance of U.S. Equities to Latin America: Exhibit 1

Relevance of U.S. Equities

Although definitions of "the market" can vary depending on one's investment objective and domicile, market participants excluding U.S. companies from their investment strategies could risk overlooking a significant portion of the global equity opportunity set.

Exhibit 2 shows that U.S.-domiciled companies accounted for 59% of the global equity market at the end of 2021. This was more than nine times the weight of the second biggest country, Japan, and more than 70 times larger than the Brazil, Chile, Colombia, Mexico and Peru segments of the S&P Global BMI, combined.

The Relevance of U.S. Equities to Latin America: Exhibit 2

The importance of U.S. equities is even more acute within some market segments. For example, Exhibit 3 shows that U.S.-domiciled companies accounted for most of the weight in 6 of the 11 global GICS® sectors at the end of 2021 and more than two-thirds of the weight in 3 sectors. Combined with the distinct sectoral composition of the U.S. equity market—for example, Appendix B shows that countries across Latin America typically have far less exposure to Information Technology, Health Care and Communication Services—U.S. exposure may be necessary to address domestic sector biases.

The Relevance of U.S. Equities to Latin America: Exhibit 3

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Concentration within Sectors and Its Implications for Equal Weighting

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Anu R. Ganti

U.S. Head of Index Investment Strategy

S&P Dow Jones Indices

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Craig Lazzara

Managing Director, Index Investment Strategy

S&P Dow Jones Indices

EXECUTIVE SUMMARY

Concerns about the degree of concentration in cap-weighted indices like the S&P 500® seem to arise whenever performance is dominated by mega-cap names—as it has recently been. A simple way to measure market concentration is to add up the weight of the largest constituents in an index. Interestingly, after peaks in concentration—such as the aftermath of the technology bubble—the S&P 500 Equal Weight Index has typically outperformed its cap-weighted counterpart.

In this paper, we propose an alternative way to measure concentration. By adjusting the Herfindahl-Hirschman Index (HHI) to account for the number of names in a sector, we’re able to make meaningful cross-sector comparisons. We show that concentration tends to mean-revert in most sectors, which has important implications for the relative performance of equal weighting. Exhibit 1 shows recent and average adjusted HHI levels across S&P 500 sectors.

Concentration within Sectors and Its Implications for Equal Weighting: Exhibit 1

A DIFFERENT WAY TO MEASURE CONCENTRATION

While looking at the weight of the top names is a simple way to assess market concentration, it’s useful to have a more comprehensive method
that incorporates all the constituents in an index. The HHI is a widely used concentration measure; it is defined as the sum of the squared index constituents' percentage weights. For example, the HHI for an equally weighted 50-stock portfolio is 200 (50 x 22). The HHI for the S&P 500 Equal Weight Index, which comprises 500 stocks, is 20 (500 x 0.22).

Previous research has shown that the long-term performance advantage of equal weight over cap-weighted strategies is driven more by equal weighting within sectors than by equal weight's differential weighting across sectors. This may occur because of unique regulatory challenges faced by the largest stocks in each sector; interestingly, the HHI is used by the U.S. Department of Justice in evaluating the competitiveness of markets and in making decisions on antitrust concerns.

Other things equal, a higher HHI indicates increased concentration, but other things may not be equal: even for completely unconcentrated equal weight portfolios, the HHI value is inversely related to the number of names. As seen above, an equally weighted 50-stock index has a higher HHI than an equally weighted 500-stock index. If we want to use the HHI to examine the history of concentration within an index, we need to adjust for the number of names. We therefore define the adjusted HHI as the index’s HHI divided by the HHI of an equally weighted portfolio with the same number of stocks. If there are n stocks in an index, the HHI for an equal-weighted portfolio is always (10,000/n). Therefore, the adjustment factor for an n-stock index is (n/10,000).

A higher adjusted HHI means that an index is becoming more concentrated, independent of the number of stocks it contains. We observe in Exhibit 2 that the adjusted HHI for the Energy sector decreased from 2014 to 2019, in spite of an increase in its raw HHI. This is because the number of constituents in the sector decreased from 43 in 2014 to 28 in 2019.

Concentration within Sectors and Its Implications for Equal Weighting: Exhibit 2

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How the Proposed Consultation on GICS Structure Changes May Affect the S&P Carbon Efficient Indices

As of Oct. 18, 2021, S&P Dow Jones Indices (S&P DJI) and MSCI Inc. (MSCI) decided to consult with members of the investment community on potential changes to the GICS structure, which will likely be announced in March 2022 and become effective in March 2023. The review was intended to ensure that the GICS structure is reflective of today’s markets and continues to be an accurate and complete industry framework.  The consultation began on Oct. 18, 2021, and ends on Feb. 18, 2022. Exhibit 1 summaries the topics for the GICS Change Consultation.

How the Proposed Consultation on GICS Structure Changes May Affect the S&P Carbon Efficient Indices: Exhibit 1

This analysis has been prepared by the Index Research & Design team of S&P Dow Jones Indices LLC (“S&P DJI”).  S&P DJI maintains an organizational/operating structure that separates commercial functions from analytical functions.  As such, the Research & Development team will not have access to any final changes that may arise out of the GICS Change Consultation until that information is made publicly available.

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