IN THIS LIST

Rotation Strategies and Their Role in the Australian Market

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

Rotation Strategies and Their Role in the Australian Market

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Priscilla Luk

Managing Director, Global Research & Design, APAC

S&P Dow Jones Indices

Sector allocation is one of the main pillars in equity portfolio management. In this paper, we examine how the sector price momentum strategy and the cyclical and defensive sector rotation strategy performed in Australia based on the S&P/ASX 200 Global Industry Classification Standard (GICS®) sector indices.

EXECUTIVE SUMMARY

  • As measured by the S&P/ASX 200, the Financials and Materials sectors have accounted for 50% of the Australian market since December 1989, but since sectors can fall in and out of favor, mimicking benchmark sector weighting may not be an optimal way to maximize portfolio returns.
  • Our study on sector price momentum shows that strong momentum sectors in recent months tend to outperform in coming months, and the opposite holds for the weak momentum sectors, suggesting that sector price momentum can be exploited in sector allocation.
  • An unoptimized portfolio with quarterly allocation to the top three sectors based on 12-month price momentum generated an annualized excess return of 4.5% compared with the market between December 1989 and June 2018.
  • Cyclical sectors in Australia represented 80% of the total market, but they underperformed defensive sectors on average over the entire period studied, and they only outperformed defensive sectors in 7 of the past 28 years.
  • Our study on cyclical and defensive sector performance across global and domestic economic cycles shows the global economic cycle is a stronger driver of relative performance of cyclical versus defensive sectors than the domestic economic cycle in Australia.
  • A dynamic allocation strategy that equal weights cyclical sectors during global economic up cycles and rotates to defensive sectors during global economic down cycles achieved an excess return of 5.2% per year compared with the Australian market.

SECTOR DIVERSIFICATION IN THE AUSTRALIAN MARKET

In a previous paper, “Is There Value in Asia Ex-Japan Sector Rotation Strategies?”, we examined how sector allocation based on price momentum and economic cycles performed in Asia, excluding Japan, and we concluded that these two strategies delivered better returns than the benchmark. In this paper, we will study how these two strategies performed in the context of Australian sectors.

Our study focuses on the 11 broad sectors classified by GICS: Energy, Materials, Industrials, Consumer Discretionary, Consumer Staples, Health Care, Financials, Real Estate, Information Technology, Telecommunication Services, and Utilities. The analysis covers the period between December 1989 and June 2018. We use the S&P/ASX 200 and S&P/ASX 200 GICS sector indices to represent the Australian market and sector performances, respectively, since March 2000, which is when the S&P/ASX 200 GICS sector returns data history begins. For dates before the beginning of the S&P/ASX 200 GICS sector index return data, we use S&P Australia BMI and S&P Australia BMI GICS sector index data.

As of month-end June 2018, the S&P/ASX 200 was diversified into 11 GICS sectors, and some of these sectors can be traded through exchangetraded funds (ETFs; see Appendix for full list of S&P/ASX sector ETFs). Financials was the largest sector in the index by weight (33.1%), consisting of 26 stocks with a combined value of more than AUD 2.2 billion traded daily. Utilities was the smallest sector in the index, weighing merely 2.0% and containing five stocks with a combined value of AUD 114 million traded daily.

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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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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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Mid-Cap Indexing in Australia

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John Welling

Director, Global Equity Indices

S&P Dow Jones Indices

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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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S&P 500® 2017: Global Sales

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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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