IN THIS LIST

Approaches to Benchmarking Listed Infrastructure

ETFs in Insurance General Accounts – 2022

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

Approaches to Benchmarking Listed Infrastructure

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Izzy Wang

Analyst, Strategy Indices

Investing in infrastructure has become popular among institutional and private investors in recent years.  Investors could be attracted to the potentially long-term, low-risk and inflation-linked profile that can come with infrastructure assets, and they may find that it is an alternative asset class that could provide new sources of return and diversification of risk.

Why Consider Investing in Infrastructure?

Infrastructure assets provide essential services that are necessary for populations and economies to function, prosper and grow.  They include a variety of assets divided into five general sectors: transportation (e.g., toll roads, airports, seaports and rail); energy (e.g., gas and electricity transmission, distribution and generation); water (e.g., pipelines and treatment plants); communications (e.g., broadcast, satellite and cable); and social (e.g., hospitals, schools and prisons).  Infrastructure assets operate in an environment of limited competition as a result of natural monopolies, government regulations or concessions.  The stylized economic characteristics of this asset class include the following.

  • Relatively steady cash flows with a strong yield component: Infrastructure assets are generally long lived. Most companies have long-term regulatory contracts or concessions to operate the assets, which can provide predictable performance over time.  As a result, infrastructure assets have the potential to generate consistent, stable cash flow streams, usually with lower volatility than other traditional asset classes.
  • High barriers to entry: Due to significant economies of scale, infrastructure assets are often regulated in such a way that discourages competition. The high barriers to entry often result in a monopoly for existing owners and operators.
  • Inflation protection: Revenues from infrastructure assets are typically linked to inflation and are often supported by regulation. In certain instances, revenue increases linked to inflation are embedded in concession agreements, licenses and regulatory frameworks.  In other cases, owners of infrastructure assets are able to pass inflation on to consumers via price increases, due to the essential nature of the assets and their inelastic demand.

Consequently, the infrastructure asset class may provide investors with a degree of protection from the business and economic cycles, as well as attractive income yields and an inflation hedge.  It could be expected to offer long-term, low-risk, non-correlated, inflation-protected and acyclical performance.

It is also generally believed that infrastructure is, as an asset class, poised for strong growth.  As the global population continues to expand and standards of living around the world become higher, there is a vast demand for improved infrastructure.  This demand includes the refurbishment and replacement of existing infrastructure worldwide and new infrastructure development in emerging markets.

Financing public infrastructure has traditionally been the responsibility of the state.  However, fiscally constrained governments are increasingly turning to the private sector to provide funding for new projects.  As a result, the investment opportunities in this sector continue to grow.

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ETFs in Insurance General Accounts – 2022

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Raghu Ramachandran

Head of Insurance Asset Channel

Introduction

In 2021, U.S. insurance companies added USD 1.5 billion in exchange-traded funds (ETFs) to their general account portfolios.  By year-end 2021, U.S. insurers increased their ETF AUM by 15% from 2020.  This 2021 growth was in line with long-term trends; in the 18 years since 2004, insurance companies have increased their ETF AUM by 15% annually.  Historically, insurance companies have invested in Equity ETFs even though the majority of their assets are in Fixed Income securities, and Equity ETFs still dominate insurance ETF holdings.  However, with the increasing acceptance of Fixed Income ETFs, we saw a significant increase in flows into these ETFs from insurance companies.  Indeed, in 2021, insurance companies added to Fixed Income ETFs while removing funds from Equity ETFs.  In our seventh annual study of ETF usage in U.S. insurance general accounts, we also analyzed the trading of ETFs by insurance companies.  On average, insurance companies traded twice as many ETFs during the year as they held at the beginning of the year.  Overall, 2021 trade volume was relatively flat compared with 2020.  This was primarily because intra-year turnover declined by 24%.

Holding Analysis

Overview

As of year-end 2021, U.S. insurance companies invested USD 45.4 billion in ETFs.  This represented only a fraction of the USD 7.2 trillion in U.S. ETF AUM and an even smaller portion of the USD 7.8 trillion in invested assets of U.S. insurance companies.  Exhibit 1 shows the growth of ETFs by U.S. insurance companies over the past 18 years

ETFs in Insurance General Accounts – 2022  - Exhibit 1

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The Relevance of U.S. Equities to Latin America

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Hamish Preston

Director, U.S. Equity Indices

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María Sánchez

Director, ESG Index Product Strategy, Latin America

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Fei Wang

Senior Analyst, U.S. Equity 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

Senior Director, Index Investment Strategy

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Craig Lazzara

Managing Director, Core Product Management

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.

Exhibit 1: Current and Average Adjusted HHI for S&P 500 GICS® Sectors

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.

Exhibit 2: Historical Adjusted and Raw HHI for S&P 500 Energy Sector

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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.

Summary of Topics for the GICS Change Consultation

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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