IN THIS LIST

Profiling Minimum Volatility

Fleeting Alpha Scorecard: Year-End 2020

Why the S&P 500 Matters to China

Political Risk and Emerging Market Equities: Applications in an Index Framework

Hidden in Plain Sight: U.S. Equities Beyond the S&P 500®

Profiling Minimum Volatility

Contributor Image
Craig Lazzara

Managing Director, Index Investment Strategy

S&P Dow Jones Indices

EXECUTIVE SUMMARY

  • Minimum volatility is part of a broader group of defensive strategies that have been in existence for decades. They are based on the low volatility anomaly, the phenomenon that lower-risk stocks outperform over time, contradicting the conventional wisdom that risk and reward go hand in hand.
  • Low volatility strategy indices attempt to exploit this anomaly systematically. The typical behavior patterns of low volatility strategies are that they go up less when the market is up and go down less when the market is down. They offer protection in down markets and participation in up markets.
  • More than with most factor strategies, the potential value added of low volatility strategies is largely dependent on market dynamics. Dispersion of returns tends to be higher in times of crisis; this disparity gives defensive strategies such as low volatility a leg up.

Profiling Minimum Volatility: Exhibit 1

INTRODUCTION

Following a few years of significant market gains, enthusiasm for low volatility strategies has waned, particularly compared with the period after the 2008 Global Financial Crisis. This is understandable since protection is probably not top of mind when things are going well and are seemingly on an upward trajectory.

THE LOW VOLATILITY ANOMALY

Low volatility strategies explicitly aim to deliver a pattern of returns relative to the market. Their goal is to reduce risk (volatility), and that goal is constant in both good times and bad.

Low volatility is a characteristic. Low volatility accompanied by outperformance is an anomaly. The phenomenon of lower-risk assets also outperforming higher-risk assets over time was noted by academics almost half a century ago.  Flouting the conventional wisdom that risk and return
go hand in hand, this phenomenon was dubbed the low volatility anomaly. Outperformance does not occur at all times (particularly in strong market performance cycles), but the anomaly has been observed universally across different markets and asset classes.

When it comes to low volatility portfolios, there are different approaches to index construction that yield different characteristics and results. In the U.S., the S&P 500 Minimum Volatility Index is one way to pursue lower risk in a systematic way.

The methodology underlying the S&P 500 Minimum Volatility Index relies on optimization, minimizing volatility subject to stock- and sector-level exposure constraints. Compared with a rankings-based methodology such as the one used for the S&P 500 Low Volatility Index, the optimized approach has typically resulted in less performance divergence from the benchmark.

Profiling Minimum Volatility: Exhibit 2

In the period from January 1991 through May 2021, the minimum volatility index delivered nearly the same return as the benchmark S&P 500, but at substantially lower risk—a 16% reduction. On a 10-year rolling basis, the S&P 500 Minimum Volatility Index’s volatility was consistently lower than the S&P 500 throughout the entire period (see Exhibit 3).

Profiling Minimum Volatility: Exhibit 3

pdf-icon PD F Download Full Article

Fleeting Alpha Scorecard: Year-End 2020

SUMMARY

The Fleeting Alpha Scorecard combines elements of the SPIVA® U.S. Scorecard and the Persistence Scorecard to show how outperforming mutual funds from one three-year period continue to perform thereafter. The former report compares actively managed funds against their passive benchmarks, while the latter compares funds against their peers.

For the Fleeting Alpha Scorecard, we first identify funds that beat their benchmarks, based on three-year annualized returns, net-of-fees. We then examine whether these funds continue to outperform during each of the next three one-year periods.

There was significant dispersion in the likelihood of funds outperforming by category, with the most notable split occuring between growth and value funds. For example, as of Dec. 31, 2017, 84 of the 261 large-cap growth funds had outperformed the S&P 500® Growth in the previous three years. Of those winners, 21 (or 25%) outperformed for the subsequent three years. But on the value side, while 78 out of 338 funds had outperformed the S&P 500® Value as of Dec. 31, 2017, only 1 of those winners managed to continue outperforming annually through 2020 (see Exhibit 1 and Report 1).

Fleeting Alpha Scorecard: Year-End 2020: Exhibit 1

In 4 of the 18 domestic equity categories tracked, no funds managed to repeat their outperformance, and fewer than 10% did so in an additional four categories (see Report 1).

Echoing a point from the SPIVA U.S. Year-End 2020 Scorecard, prior to the evaluation of alpha persistence, few funds beat the benchmark for the initial three years (2015-2017). In 13 of the 18 domestic equity categories, fewer than 20% surpassed the benchmark, significantly reducing the original universe into the pool of "winners" for subsequent tracking.

International equity funds had slightly higher rates of outperformance in the initial period and were more stable in their alpha maintenance across categories and time. The conspicuous exception was emerging market funds where no active manager managed to repeat their positive alpha through 2020.

We take into consideration that cyclical market conditions can unduly influence a snapshot of the performance persistence figure. The figures in Report 2 are calculated by: 1) creating a version of Report 1 for each quarter between December 2011 and December 2020, and 2) taking simple averages of the persistence figures for each of the categories.

This analysis showed that the average outperformance persistence in each of the subsequent three years fell rapidly. Across all funds in the tracking universe, the average outperformance persistence by year was 33.8%, 13.7%, and 6.7%, respectively.

The growth/value split was visible in this longer timeframe as well. As Exhibit 2 shows, while the percentage of outperforming value funds was reasonably similar to their growth counterparts in year one, their alpha proved substantially less durable, suffering a harsher decline by year three.

Fleeting Alpha Scorecard: Year-End 2020: Exhibit 2

pdf-icon PD F Download Full Article

Why the S&P 500 Matters to China

Contributor Image
Jason Ye

Director, Factors and Thematics Indices

S&P Dow Jones Indices

Contributor Image
Hamish Preston

Head of U.S. Equities

S&P Dow Jones Indices

EXECUTIVE SUMMARY

Chinese investors tend to have high exposure to domestic equities and low exposure to international equities.  This home-country bias is common among investors globally.  U.S. equities represented 45% of the global equity market, as of Dec. 31, 2020.  Underallocation to international equities, including U.S. equities, means Chinese investors may be foregoing potential diversification benefits.

In this paper, we:

  • Discuss the global investment opportunities for Chinese investors and the potential results of investing globally;
  • Introduce the S&P 500 and explain how it is constructed;
  • Highlight how the S&P 500 could affect Chinese investors’ ability to diversify domestic sector biases, gain exposure to U.S. economic growth, and improve historical risk-adjusted returns; and
  • List different channels where Chinese investors may access global markets and review the Qualified Domestic Institutional Investor (QDII) program.

Why the S&P 500 Matters to China: Exhibit 1

pdf-icon PD F Download Full Article

Political Risk and Emerging Market Equities: Applications in an Index Framework

Contributor Image
Hector Huitzil Granados

Analyst, Global Equity Indices

S&P Dow Jones Indices

INTRODUCTION

Political risk is widely presumed to affect emerging market equities. However, its impact has historically been difficult to assess due to the lack of quantifiable, systematic, and standardized political risk metrics.

The growing popularity of alternative data derived from natural language processing and sentiment analysis of global news media has opened new opportunities in the political risk space, including novel methods of devising systematic investment and asset allocation frameworks that are uniquely informed by a new generation of political risk indicators.

To take advantage of this development, S&P Dow Jones Indices has collaborated with GeoQuant, an AI-driven political risk data firm, to devise a best-in-class Emerging Markets Political Risk-Tilted Concept Index (hereafter the “Political Risk-Tilted Concept Index” or "Concept Index").

The Concept Index takes the S&P Emerging BMI as its starting point and rebalances country allocations monthly based on GeoQuant's custom "Macro-Government Political Risk Indicator," yielding the Political Risk-Tilted Concept Index by overweighting (underweighting) countries with relatively low (high) political risk.

We find that systematically incorporating political risk as a factor into emerging market equity allocation decisions can potentially drive outperformance relative to the benchmark S&P Emerging BMI. Outperformance is largely attributable to reduced overall volatility and greater insulation from downside risk.

Over a 2013-2020 back-test period, the Concept Index outperformed the S&P Emerging BMI using a standard set of back-test parameters. Specifically, the Concept Index yielded higher return/risk ratios over three-and five-year horizons, and on a cumulative basis over the full back-tested period, with an annualized excess return of 1.31% relative to its benchmark. It also demonstrated a consistently lower level of volatility, a relatively low annualized tracking error of 2.03%, and a lower monthly average turnover than its benchmark. On a monthly basis, the back-tested Concept Index outperformed the S&P Emerging BMI in the majority of all months, and in a larger majority of down months in which benchmark returns decreased. The back-test also outperformed the S&P Emerging BMI over 2020 despite well-known challenges in forecasting equity market performance during the COVID-19 pandemic.

The Political Risk-Tilted Concept Index is the first of its kind (to the best of our knowledge) and offers novel opportunities to leverage S&P Dow Jones Indices and GeoQuant data to inform emerging market equity allocation decisions.

MEASURING POLITICAL RISK: AN OVERVIEW

GeoQuant is a venture-backed, AI-driven political risk data firm that fuses political science and machine learning to systematically measure and predict political risks in real-time.

Well before COVID-19, the interplay of macro-economic policymaking and government (in)stability, and the lack of high-frequency data to measure these factors, made it notoriously difficult to assess the impact of political risk on equity prices, particularly in emerging markets. Technical advances in monitoring and predicting political risk were necessary.

To that end, GeoQuant has developed a best-in-class set of more than 20 political risk indicators for modeling and understanding the impact of political risk on markets. These indicators enable data-driven and systematic asset allocation in response to measurable, real-time variation in political risk.

Exhibit 1 provides a snapshot of GeoQuant’s core set of risk indicators, which collectively comprise GeoQuant’s "Fundamental Risk Model." The indicators measure the full spectrum of risks that are likely to affect commerce, trading, investment decisions, and intergovernmental relations. All indicators are generated by real-time natural language processing of traditional news media using proprietary algorithms for text-based sentiment analysis, as well as synchronous inputs and review by a team of PhD political economists.

pdf-icon PD F Download Full Article

Hidden in Plain Sight: U.S. Equities Beyond the S&P 500®

Contributor Image
Tim Edwards

Managing Director and Global Head of Index Investment Strategy

S&P Dow Jones Indices

Contributor Image
Sherifa Issifu

Senior Analyst, U.S. Equity Indices

S&P Dow Jones Indices

EXECUTIVE SUMMARY

• Mid- and small-cap U.S. equities represent a significant piece of the global market, but they are overlooked by many international investors, particularly those in Europe.

• The S&P MidCap 400® and S&P SmallCap 600® are simple, transparent benchmarks for U.S. mid and small caps. Over the past 20 years, they have outperformed the S&P 500, as well as a majority of actively managed U.S. equity funds in their respective size segment.

• Exhibit 1 summarizes the potential opportunity set for diversification by European fund investors, comparing the global equity market weight of U.S. small and mid caps to their estimated aggregate allocations within European-based equity funds.

Hidden in Plain Sight: U.S. Equities Beyond the S&P 500: Exhibit 1

INTRODUCTION

The U.S. stock market includes many of the world's largest and best-known companies, and investors the world over have allocated capital to U.S. equities. However, many investors appear to have explored little beyond the so-called "blue chips." As shown in Exhibit 1, European fund investors, in particular, have relatively minimal exposure to small- or mid-sized U.S. equities.

This lack of interest is puzzling, not least because U.S. mid and small caps represent significant market segments in absolute terms. At the end of 2020, the S&P MidCap 400 alone had a market capitalization similar to the entire French stock market, while the U.K.'s stock market, the largest in Europe, was roughly the same size as the mid- and small-cap indices combined.

Adding to the puzzle, historical performance is unlikely to have been a deterrent to European investors; the S&P MidCap 400 and S&P SmallCap 600 significantly outperformed the S&P 500, S&P United Kingdom BMI, and S&P Europe 350® over the past 26 years. Exhibit 2 illustrates their performance graphically (British pound, euro, and U.S. dollar performances are reported in Exhibit 10).

Hidden in Plain Sight: U.S. Equities Beyond the S&P 500: Exhibit 2

pdf-icon PD F Download Full Article
Processing ...