ETFs in Insurance General Accounts 2019

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?

How Smart Beta Strategies Work in the Chinese Market

Research - May 21, 2019

Raghu Ramachandran

Head of Insurance Asset Channel

INTRODUCTION

In our last report, we showed that in 2017, insurance companies increased their use of exchange-traded funds (ETFs) by a significant amount (37% year-over-year). In 2018, insurance companies continued to increase their use of ETFs and, in spite of a market correction in the Q4 2018, held ETF assets in line with long-term growth trends. Furthermore, in 2018, the industry also displayed a divergence in their investment patterns—with companies that had previously been slow to adopt ETFs increasing their usage, and other companies, which in the past had grown ETF usage rapidly, retrenching. A divestment from Smart Beta ETFs, in particular, caused a drag on the overall share ownership and AUM of insurance companies invested in ETFs. In our fourth annual analysis of ETF usage in insurance general accounts, we explore the changing dynamics and current usage of over 1900 companies in this market.

OVERVIEW

As of year-end 2018, U.S. insurance companies had USD 26.2 billion invested in ETFs. This represents a tiny fraction of the USD 3.4 trillion of ETF assets under management (AUM) and an even smaller portion of the USD 6.3 trillion in admitted assets of U.S. insurance companies. While ETF AUM steadily increased over the prior six years, in 2018, the AUM of ETFs in the industry declined for the first time since 2011. In 2018, U.S. insurance company ETF AUM decreased by 3% from the prior year. However, usage still showed a double-digit compound annual growth rate (CAGR) over the 3-, 5-, and 10-year periods.

The last quarter of 2018 had marked downturn in the equity and fixed income markets. The S&P 500 dropped 14% in the 4th quarter; a week before year-end the S&P 500 was off 20%. On December 19th, 2018 the Federal Reserve increased the Fed Funds rate for a fourth and last time in 2018. And even though 10-year Treasury and corporate yields fell during the quarter, corporate spread increased by a larger amount in the Q4 2018. To test if market volatility in Q4 2018 depressed the year-end AUM numbers, we also looked at the number of shares held by insurance companies. Unlike AUM, the number of shares of ETFs used by insurance companies continued to increase in 2018.

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Research - May 17, 2019

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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Research - May 15, 2019

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

Priscilla Luk

Managing Director, Global Research & Design, APAC

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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Research - May 07, 2019

Is the Low Volatility Anomaly Universal?

Craig Lazzara

Managing Director, Index Investment Strategy

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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Research - Apr 10, 2019

How Smart Beta Strategies Work in the Chinese Market

Liyu Zeng

Director, Global Research & Design

Priscilla Luk

Managing Director, Global Research & Design, APAC

EXECUTIVE SUMMARY

In response to the increasing interest in smart beta strategies in the Chinese equity market, we examined the effectiveness of six well-known risk factors—size, value, low volatility, momentum, quality, and dividends— in that market from July 31, 2006, to Nov. 30, 2018.

All the risk factors delivered absolute and risk-adjusted quintile return spreads, with the low volatility, value, and high dividend portfolios generating the highest risk-adjusted return spreads.
All the Chinese factor indices offered by S&P DJI, except the momentum index, generated absolute and risk-adjusted excess returns in the long run. The low volatility and high dividend indices delivered the highest absolute and risk-adjusted returns, while only the low volatility index had reduced return volatility and drawdown compared with the S&P China A BMI.
S&P DJI’s various Chinese factor indices behaved differently during up and down markets. The momentum index tended to perform better in up markets, but the low volatility, value, quality, and dividend indices had better returns in down markets.
Our macro regime analysis showed that most factor portfolios in China were sensitive to local market cycles and investor sentiment regimes.
Factor strategies can be useful tools for the implementation of active views on the Chinese equity market due to distinct cyclicality in factor performance.

FACTOR-BASED INVESTING IN THE CHINESE EQUITY MARKET

Smart beta strategies are gaining significant attention in the asset management industry, and the exchange-traded products (ETPs) tracking factor indices have shown significant asset growth since the end of 2008. Factor-based strategies are a category of smart beta strategies that target specific risk factors. They have characteristics of passive investing, such as rules-based construction, transparency, and cost efficiency; they also share features of active investing in that they aim to enhance return and reduce risk compared with traditional market-cap-weighted indices.

Single-factor indices are constructed to capture a specific risk factor. They exhibit distinct cyclicality in response to a changing market environment, which also makes them ideal tools for the implementation of active views.

In China, we observe increasing interest in factor-based investing in the equity market, although it lags the U.S. and some other Asian markets (like Japan). Dividend products still dominate the Chinese factor-based ETP market.

In this paper, we examined the effectiveness of six well-known risk factors (size, value, low volatility, momentum, quality, and dividend) in the Chinese equity market and the behavior of these factors under different market regimes.

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