Earnings Revision Overlay on Fundamental Factors in Asia

Combining Low Volatility and Dividend Yield in U.S. Preferred Stocks

Mid-Cap Indexing in Australia

S&P 500^® 2017: Global Sales

S&P 500^® Corporate Pensions and Other Post-Employment Benefits (OPEB) in 2017

Research - Sep 04, 2018

Earnings Revision Overlay on Fundamental Factors in Asia

EXECUTIVE SUMMARY

In this research paper, we explore the effectiveness of overlaying earnings revision strategies on traditional fundamental value and quality factors across seven Pan Asian markets—Australia, China, Hong Kong, India, Japan, South Korea, and Taiwan—between March 31, 2006, and March 31, 2018.

HIGHLIGHTS

The earnings revision-screened factor portfolios outperformed their respective comparable factor portfolios across the majority of Pan Asian markets for the value and quality factors.
Our screening approach did not introduce a large increase in portfolio turnover or strong sector or size biases to the fundamental factor portfolios historically.
Among various Asian markets, the earnings revision overlay generated the most significant excess return in Australia and Hong Kong for a majority of fundamental factors.

INTRODUCTION

In our previous research paper “Do Earnings Revisions Matter in Asia?”, we concluded that stock prices tended to move in the same direction as their earnings revisions in the majority of Pan Asian markets, and the earnings revision strategies delivered excess returns in a majority of the markets. Due to the high portfolio turnover of this strategy, using earnings revision as an overlay to fundamental factors may be more practical.

The goal of this research is to evaluate the effectiveness of earnings revision strategies over the fundamental factor portfolios. We overlaid two earnings revision screens (EPS change and EPS diffusion) on the fundamental value and quality factor portfolios, respectively. Specifically, we examined if the earnings revision screens were historically effective in generating return alpha or reducing the risk of the factor portfolios by filtering out the stocks with relatively poor earnings revisions from the factor portfolios.^¹

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Research - Aug 24, 2018

Combining Low Volatility and Dividend Yield in U.S. Preferred Stocks

INTRODUCTION

Preferred stocks are hybrid securities that sit between common stocks and bonds in a company’s capital structure, therefore exhibiting blended characteristics of both asset classes. They have been favored by incomeseeking investors due to the higher yields they offer in comparison with common stocks and corporate bonds.

Historically, dividends have been a dominating driver for the total return of preferred stocks. Therefore, many preferred strategies seek to capture the benefit of higher-dividend-yielding preferred stocks.

However, as with any income-oriented strategy, it is important to avoid falling into a yield trap. In particular, our research in equity dividends has shown that securities in the top quintile of the yield-ranked universe have higher volatility and lower risk-adjusted returns than those in other quintiles.¹ Similarly, this paper shows that higher-dividend-yielding preferred stocks also tend to exhibit higher volatility, and therefore an income strategy may require some form of volatility management for prudent portfolio construction.

Against that backdrop, we applied the low volatility factor, which is popular in equity investing, to preferred stocks. The low volatility effect refers to the finding that, historically, stocks with low volatility have tended to outperform their high volatility peers on a risk-adjusted basis. It has been extensively studied in equities by academics and practitioners alike and stock investment vehicles linked to low volatility strategies have grown significantly. Our analysis shows that the low volatility factor can be overlaid with a high-dividend strategy in preferred stocks to manage volatility while maintaining attractive yield levels.

The remainder of this paper is organized as follows. The first section explores a high-dividend investment strategy and extends the study of the low volatility effect in U.S. preferred stocks. The second section introduces the methodology of the S&P U.S. Preferred Stock Low Volatility High Dividend Index. The third and fourth sections present back-tested performance and characteristics of the index, respectively.

HIGH-DIVIDEND INVESTING AND LOW VOLATILITY EFFECT IN PREFERRED STOCKS

Preferred Stock Total Return Analysis

Preferred stocks exhibit blended characteristics of stocks and bonds. They represent ownership in companies, but they do not come with voting rights. Given their junior position to bonds in capital structure, preferred stocks generally offer higher yield than senior bonds, and higher stable dividends than common stocks, and therefore are popular instruments for incomeseeking investors.

Historically, dividend income contributes significantly to preferred stock total return. To illustrate, Exhibit 1 compares the price returns and total returns of the S&P U.S. Preferred Stock Index and S&P 500® . From its inception in 2003 until May 31, 2018, the S&P U.S. Preferred Stock Index generated a cumulative total return of 114.8%, while its price return was -22%. This is in contrast with the S&P 500, for which total return followed price return closely, and price return contributed 64% of the total return since 2003.

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Research - Aug 17, 2018

Mid-Cap Indexing in Australia

John Welling

Director, Global Equity Indices

S&P Dow Jones Indices

Michael Orzano

Head of Global Exchanges Product Management

S&P Dow Jones Indices

The mid-cap space has often been described as the “sweet spot” of equity investing—and with good reason. Mid caps tend to offer a balance between the high growth (and high risk) offered by small caps and the stability (but slower growth) of large caps. In addition, the Australian midcap segment has a more diverse sector representation than both large-cap and broad-market Australian benchmarks, which are dominated by banks. Over the long term, these unique characteristics have helped the Australian mid-cap segment outperform all other size categories on both an absolute and risk-adjusted basis.

Despite these characteristics, the mid-cap segment of the Australian stock market is often overlooked and underappreciated. Pure mid-cap investing is not common, and often, mid- and small-cap companies are lumped together for investment purposes, diluting the unique characteristics of midsized companies.

“SIZING UP” THE AUSTRALIAN MARKET

Encompassing approximately AUD 266 billion in market capitalization, as measured by the S&P/ASX MidCap 50 , mid-cap companies represent about 14% of the broad-market S&P/ASX 300 . Small-cap companies, as measured by the S&P/ASX Small Ordinaries , represent nearly 13%.

Exhibit 1 illustrates the index characteristics of the different size indices that combine to form the S&P/ASX 300.

MID-CAP FUNDAMENTALS DRIVE UNIQUE PERFORMANCE

Many mid-cap companies are still in the growth phase, but they typically possess greater maturity than their small-cap counterparts. These companies may offer market participants the best of the large- and smallcap worlds before potentially reaching large-cap status. Mid-cap stocks present an opportunity for distinct fundamental exposure, given the unique life cycle characteristics of mid caps.

Mid-cap stocks are distinct, with their fundamentals demonstrating a unique stage of development that typically allows for higher growth rates than large-cap companies and greater access to capital than small-cap companies (see Exhibits 2a to 2c). Exhibits 2a and 2b demonstrate that mid-cap companies, as represented by the S&P/ASX MidCap 50 , have experienced meaningfully higher median revenue and normalized net income growth than large-cap companies, while also comparing favorably to the broad-market S&P/ASX 200 and S&P/ASX 300 .

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Research - Aug 16, 2018

S&P 500^® 2017: Global Sales

Howard Silverblatt

Senior Index Analyst, Product Management

S&P Dow Jones Indices

YEAR IN REVIEW

In 2017, the percentage of S&P 500 sales from foreign countries increased slightly, after two years of measured decreases. The overall rate for 2017 was 43.6%, up from 43.2% in 2016, but down from 44.3% in 2015 and 47.8% in 2014, which was at least an 11-year record high. S&P 500 foreign sales represent products and services produced and sold outside of the U.S.

Sales in Asia declined, but they remained the highest of any region. Asia accounted for 8.26% of all S&P 500 sales, down from 8.46% in 2016, but up from 2015’s 6.77% and 2014’s 7.80%.

European sales ticked up for 2017, but they remained lower than Asia. For 2017, European sales increased to 8.14% of all sales, up from 8.13% in 2016, 7.79% in 2015 and 7.46% in 2014. The UK (which is part of European sales) increased to 1.12% from 2016’s 1.10%, after 2015’s increase to 1.86%.

Japanese sales decreased to 1.51% of all S&P 500 sales from 1.52% in 2016, and African sales inched down to 3.90% from 3.97% in 2017. Sales in Canada declined to 2.16% from 2.67% in 2016, after declining significantly to 1.17% in 2015 from 3.51% in 2014 (oilrelated sales were seen as a contributing factor).

Information technology had the most foreign exposure of any sector, even though it declined to 56.95% from 2016’s 57.15%. Energy, which was last year’s lead sector, declined to 54.06% from 58.88% in 2016.

Given the ongoing debate and legislative actions on sales, tariffs, and jobs, the level of specific data disclosed by companies continues to be disappointing.

OVERVIEW

In 2002, we removed foreign issues from the S&P 500. However, being an American company (or defined as an American company) doesn’t mean you’re not global. While globalization is apparent in almost all company reports, exact sales and export levels remain difficult to obtain. Many companies tend to categorize sales by regions or markets, while others segregate government sales. Additionally, intracompany sales—and hence, profits—are sometimes structured to take advantage of trade, tax, and regulatory policies. Changes in domicile, inspired by tax savings, have also changed the technical classification of what is considered foreign. Therefore, the resulting reported data available to shareholders is significantly less substantial and less revealing than the data that would be necessary to complete a truly comprehensive analysis. However, using the data that is available, we do offer an annual report on foreign sales, which is designed to be a starting point that provides a unique glimpse into global sales composition, but it should not be considered a statement of exact values.

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Research - Aug 06, 2018

S&P 500^® Corporate Pensions and Other Post-Employment Benefits (OPEB) in 2017

Howard Silverblatt

Senior Index Analyst, Product Management

S&P Dow Jones Indices

Providing Americans with adequate retirement income and affordable medical care was one of the country's most hotly debated social and political topics of the 20th century. However, the times have changed, along with longevity, as the medical cost of that prolonged longevity has risen, and corporations’ ability to absorb the risks associated with multidecade portfolios to finance those commitments has fallen. Over the past three decades, corporations in the private sector have successfully shifted the responsibility of retirement to individuals, as programs have been frozen or closed to new employees, with 401(k)-type saving programs acting as substitutes. What remains is a lingering program of the past that will slowly decline in size and number of covered retirees over the coming decades. For now, both S&P 500 pensions and OPEB remain a manageable cost with sufficient resources and cash flow to support them— as slowly increasing interest rates could improve funding via lower discounted liabilities for 2018. For 2017, corporate pension underfunding stood at USD 304 billion—22.1% lower than the USD 391 billion level of 2016, as markets posted a second year of impressive double-digit gains. The funding level increased to 85.62% in 2017 from 80.75% in 2016, 81.14% in 2015, and 81.12% in 2014. The most recent low-funding level was in 2012, at 77.26%, with the last full-funding level occurring in 2007, at 104.40%.

Clearly, the traditional defined-benefit corporate pension has become a relic of an earlier age, one that dates back to World War II, when the average American's life expectancy was 65 years. By 1974, when Congress passed the Employee Retirement Income Security Act (ERISA; the federal law that sets minimum standards for most voluntarily established pensions in the private industry), Americans’ average life expectancy had risen to 72 years. Today (according to the Center for Disease Control), the average life expectancy in the U.S. is 78 years (76 years for men and 81 years for women). In 1983, when the life expectancy was 74, the official Social Security age of "full retirement" was scaled forward from 65 years to 67 years, depending on the year of birth, as longevity continues to move up. Medicare eligibility, however, has remained at 65. As a result, post-employment medical costs associated with longevity have skyrocketed, as have the costs of prescription drugs and elder care.

OVERVIEW

Equity markets continued to set new highs last year, posting double-digit returns and outpacing the cost of lower interest rates, which have pushed up discounted liabilities, resulting in a 22.1% improvement in underfunding for 2017.
Interest rates utilized for discounted pension liabilities again declined in 2017, after 2015’s significant increase, and are less than half of those used in 2001.
Expected pension return rates declined for the 17th year in a row.
Most corporations have successfully shifted the burden of risk for retirement to the employee, as 401(k)-type savings accounts have become the norm, and active defined-benefit pensions in the private sector have become few and far between.
Given the dwindling coverage, the current obligations of pensions and OPEB are a manageable expense for most companies.
OPEB coverage continues to decline, as fewer covered retirees cost more per person, but are a quantifiable cost with a declining obligation.

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