IN THIS LIST

Building Better International Small-Cap Benchmarks

The S&P MidCap 400®: Outperformance and Potential Application

Benchmarking Corporate Effectiveness: How the S&P Drucker Institute Corporate Effectiveness Index Captures a More Complete Picture

The Beauty of Simplicity: The S&P 500 Low Volatility High Dividend Index

Is the Low Volatility Anomaly Universal?

Building Better International Small-Cap Benchmarks

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Phillip Brzenk

Managing Director, Global Head of Multi-Asset Indices

S&P Dow Jones Indices

INTRODUCTION

Since the documentation of the size premium, a market participants have increasingly seen small-cap stocks as a distinct asset class and have started to maintain a dedicated, separate allocation apart from large caps. In recent years, research has shown that quality is the prominent driver of returns in the small-cap space.b Asness et al. found that the variability of the size effect mainly stemmed from the volatile performance of low-quality, or junk, small-cap firms. When junk or low quality is controlled for, the size premium becomes more robust in nature and is found across industries, time periods, and 23 different markets.

Based on evidence found in “A Tale of Two Benchmarks: Five Years Later” and effectiveness across regions in Asness et al., we investigated whether quality has earned a similar premium in international small-cap benchmarks. We tested a number of profitability metrics and found that for international small-cap universes, companies with positive earnings, or higher profitability ratios, incorporated as an inclusion requirement outperformed portfolios without such a requirement. The results were consistent regardless of the profitability metric used and region tested.

In order to capture the positive earnings return premia seen in the profitability metrics testing results, the S&P Global SmallCap Select Index Series was launched in late 2018. The series is designed to measure the performance of small-cap companies with positive earnings, with most based on the S&P Global BMI universe. The series includes indices representing multiple regions, such as global, global ex-U.S., developed exU.S., and emerging markets. It provides several key benefits over traditional small-cap benchmarks, including improved risk-adjusted returns (see Exhibit 2), low tracking error, and enhanced liquidity. We additionally found that the series raises the bar for active manager performance measurement relative to the traditional small-cap benchmarks (see Exhibit 19).

EARNINGS RETURN PREDICTABILITY

A profitability requirement—even something as simple as screening out unprofitable companies using earnings per share (EPS)—could have a positive return impact for an international small-cap benchmark.

To determine if profitability is a driver of performance in the international small-cap space, we explored six common measures of profitability. These are EPS,1 asset turnover, gross profit margin, gross profitability, return on assets (ROA), and return on equity (ROE).2 We compared the six-month forward returns of companies with positive (or higher) profits to ones with negative (or lower) profits. To check if geographical differences played a role, we tested the metrics across four universes, including global, global ex-U.S., developed ex-U.S., and emerging markets.

Monthly, we ranked companies in each universe and grouped them into quintiles, with the most profitable (highest) companies placed into the Quintile 1 and least profitable (lowest) companies placed into Quintile 5. For EPS, we placed companies in two groups, companies with positive earnings and companies with negative earnings. We equally weighted companies within each group to avoid size bias and calculated returns in local currency to avoid currency effect. Exhibit 3 shows the average of the forward six-month returns for each metric from November 1999 to April 2018.

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The S&P MidCap 400®: Outperformance and Potential Application

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Louis Bellucci

Senior Director, Index Governance

S&P Dow Jones Indices

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Hamish Preston

Head of U.S. Equities

S&P Dow Jones Indices

EXECUTIVE SUMMARY

Mid-cap stocks have often been overlooked in favor of other size ranges in investment practice and in academic literature. Yet mid-caps have outperformed large- and small-caps, historically: the S&P MidCap 400 has beaten the S&P 500® and the S&P SmallCap 600® by an annualized rate of 2.03% and 0.92%, respectively, since December 1994. To better understand the historical outperformance by mid-caps, as well as their potential use within an investment portfolio, this paper:

  • Provides an overview of S&P Dow Jones Indices’ methodology for defining the U.S. mid-cap equity universe;
  • Outlines the so-called “mid-cap premium,” analyzing it from factor and sector perspectives;
  • Shows that active managers have underperformed the S&P MidCap 400, historically;
  • Highlights how mid-caps can be incorporated within a portfolio.

INTRODUCTION

U.S. equity indices have a long history of measuring the performance of market segments. The Dow Jones Transportation Average™, the first index and a precursor to the Dow Jones Industrial Average®, was created in 1884. The inaugural capitalization-weighted U.S. equity index was first published in 1923 and evolved into today’s widely followed 500-company U.S. equity benchmark—the S&P 500.

More recently, after academic literature demonstrated the existence of a size factor, index providers developed benchmarks to track the performance of smaller companies. Among them were the S&P MidCap 400 and the S&P SmallCap 600, launched in June 1991 and October 1994, respectively.

Despite the historical outperformance of mid-cap stocks, they appear to be under-allocated compared to small-caps. Exhibit 2 shows the proportion of assets invested in core U.S. equities, across the large-, mid-, and small-cap size ranges, by U.S.-domiciled retail and institutional funds at the end of 2018. Based on overall market capitalization, we might expect funds to allocate twice as much to mid-caps compared to smallcaps. Instead, the aggregate core allocation to small- and mid-caps is approximately the same: investors appear to have a preference for smallcaps over mid-caps in their core holdings. The data shows this preference is especially true for active funds.

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Benchmarking Corporate Effectiveness: How the S&P Drucker Institute Corporate Effectiveness Index Captures a More Complete Picture

EXECUTIVE SUMMARY

  • Since the 1970s, U.S. corporate executives have emphasized shareholder value over stakeholder capitalism. This has lately come to be seen as overdone and unwise for a company’s longterm benefit.  The intangible aspects of corporate performance emphasized by stakeholder capitalism are important factors in value creation.
  • The Drucker Institute created an intangibles-focused model based on the principles of management theory’s definitive thinker, Peter Drucker, to assess corporate effectiveness in five dimensions: employee engagement and development, customer satisfaction, innovation, social responsibility, and financial strength.
  • S&P Dow Jones Indices has combined the Drucker Institute’s four non-financial dimensions with S&P DJI’s definition of financial quality, the quality factor, to provide a holistic approach.
  • The S&P Drucker Institute Corporate Effectiveness Index calculates a combined average score for each stock in the S&P 500®, then further selects the stocks with the best blend of combined average score and consistency across dimension scores.
  • The index exhibits an improved risk/return profile compared with the S&P 500 and offers a uniquely differentiated approach to capture companies that reinvest in stakeholders.

INTRODUCTION

This paper details the investment rationale and the construction of the S&P/Drucker Institute Corporate Effectiveness Index. This index is designed to measure the performance of companies in the S&P 500 using the Drucker Institute’s holistic model for valuing corporate intangibles based on managerial effectiveness.

The Drucker Institute is not alone in its work in this area. Among the most prominent current players is the Embankment Project for Inclusive Capitalism (EPIC), led by Ernst & Young and 19 of the world’s largest asset managers and owners, including Vanguard, State Street, and CalPERS. In 2018, EPIC wrote, “Nearly two decades into the 21st century, businesses worldwide are still reporting to financial markets based on accounting principles and concepts that were first codified in accounting standards in the 1970s to record financial transactions...Today, it is not uncommon that as little as 20% of a company’s value is captured on its balance sheet—a staggering decline from about 83% in 1975.”2

The EPIC report is a reaction to the period between the early 1970s and today, when shareholder capitalism overtook stakeholder capitalism as the most profitable business principle for corporations and their investors. From the 1940s through the 1970s, America’s leading executives spoke frequently about their responsibility to address the needs of all of their constituents. 3 However, by the early 1980s, buoyed by the theories of the University of Chicago’s Milton Friedman,4 the University of Rochester’s Michael Jensen,5 and other academics, “maximizing shareholder value” became the new standard.

As shareholder primacy took hold across the business landscape, evaluation of corporate performance was boiled down, in many respects, to a single number: a company’s daily share price. Although some still applaud “maximizing shareholder value” as consistent with a company flourishing over the long run, 6 this mindset often prompts executives to behave in short-sighted ways that reward them for trading long-term growth for short-term returns. 7

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The Beauty of Simplicity: The S&P 500 Low Volatility High Dividend Index

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Priscilla Luk

Managing Director, Global Research & Design, APAC

S&P Dow Jones Indices

EXECUTIVE SUMMARY

We take an in-depth look at the S&P 500® Low Volatility High Dividend Index, examining how the simple, two-step constituent screening methodology captures the benefit of high dividend and low volatility strategies to achieve higher dividend yield and better risk-adjusted returns than other S&P Dow Jones Dividend Indices that use multiple dividend and fundamental quality screens.

  • The low volatility screen acted as a quality measure to avoid highyield stocks with sharp price drops and captured the low volatility factor for the S&P 500 Low Volatility High Dividend Index.
  • The S&P 500 Low Volatility High Dividend Index historically delivered a higher absolute and risk-adjusted return than the S&P 500 from December 1990 to February 2019.
  • The index outperformed the S&P 500 73% of the time in down markets and underperformed 61% of the time in up markets. However, the level of outperformance in down markets was more pronounced than the level of underperformance in up markets.
  • Compared with other S&P Dow Jones Dividend Indices in the U.S., the S&P 500 Low Volatility High Dividend Index achieved higher dividend yield and risk-adjusted returns historically.


    • 1. INTRODUCTION

    With the S&P 500 Low Volatility High Dividend Index marking six and half years since its launch, we reexamined the advantage of incorporating a low volatility screen to a high-dividend-yield portfolio as a quality measure, and we compared the S&P 500 Low Volatility High Dividend Index to other S&P Dow Jones Dividend Indices in the U.S. market across various aspects such as sector composition, dividend yield, and historical return, among others.

    Dividend investment strategies have inspired widespread academic research, and they have been adopted extensively by market participants. In response to the demand for benchmarks in this investment arena, S&P Dow Jones Indices offers a series of dividend strategy indices that are each designed to meet specific needs.

    The Dow Jones U.S. Select Dividend Index is designed to measure U.S. companies that pay high dividends with sustainable dividend growth and payout ratios. The S&P High Yield Dividend Aristocrats® and the S&P 500 Dividend Aristocrats are designed to measure the performance of companies within the S&P Composite 1500® and the S&P 500 that have consistently increased dividends over the past 20 and 25 years, respectively. The Dow Jones U.S. Dividend 100 Index seeks to measure the performance of the highest-yielding U.S. companies with a consistent dividend payment history and robust financial strength. The S&P 500 High Dividend Index is designed to track S&P 500 members that offer high dividend yield.

    In September 2012, S&P Dow Jones Indices launched the S&P 500 Low Volatility High Dividend Index, which is a unique, rules-based, dividend strategy index that is designed to deliver high dividend yield and low return volatility in a single index. The index uses a simple, two-step screening process to incorporate not only high dividend yield, but also the well-known low volatility strategy.

    We first published this paper in October 2013 to share our analysis on the benefit of combining low volatility and high-dividend strategies in a single index. We concluded that simply excluding high volatility stocks from a high-dividend-yield portfolio may improve portfolio return on a risk-adjusted basis, and the S&P 500 Low Volatility High Dividend Index has achieved higher dividend yield and better risk-adjusted returns than other S&P Dow Jones Dividend Indices that use dividend history criteria and multiple fundamental quality screens.

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Is the Low Volatility Anomaly Universal?

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Craig Lazzara

Managing Director, Index Investment Strategy

S&P Dow Jones Indices

EXECUTIVE SUMMARY

  • Portfolio managers have run defensive equity strategies for decades. Low volatility has become an important factor in the 10 years since the 2008 financial crisis.
  • The low volatility anomaly challenges the conventional wisdom about risk and return—low volatility stocks, by definition, exhibit lower risk, but they have also outperformed their benchmarks over time. This phenomenon is observed universally across the globe.
  • Low volatility strategies also exhibit a distinctive pattern of returns that is observable across capitalization tranches and geographic regions. They offer protection in down markets and participation in up markets.
  • Low volatility’s performance benefits from an asymmetry. Return dispersion tends to be above average when low volatility outperforms, and below average when low volatility underperforms.

Is the low volatility anomaly universal?: Exhibit 1

INTRODUCTION

Low volatility investing gained immense popularity in the last decade. A proliferation of passive investment vehicles based on this concept attracted more than $70 billion in assets globally as of the end of February 2019.

The low volatility phenomenon is not, however, a new concept; academics first wrote about it more than four decades ago. Low volatility strategies are familiar in the investment world; portfolio managers have sought volatility reduction, explicitly or otherwise, for as long as there have been portfolio managers.

In the U.S., the S&P 500 Low Volatility Index was the first index vehicle to exploit this phenomenon systematically. Since 1991, the index has outperformed the S&P 500; more importantly, it has done so at a substantially lower level of volatility. Furthermore, the phenomenon is found in all markets segments and regions we have observed.

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