IN THIS LIST

Sector Effects During Elections

Conviction, Confidence, and Courage

Fleeting Alpha Scorecard: The Challenge of Consistent Outperformance Year-End 2019

The VIX Index and Volatility-Based Global Indexes and Trading Instruments

How Smart Beta Strategies Work in the Australian Market

Sector Effects During Elections

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Craig Lazzara

Managing Director, Index Investment Strategy

S&P Dow Jones Indices

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Anu R. Ganti

U.S. Head of Index Investment Strategy

S&P Dow Jones Indices

“When we got into office, the thing that surprised me most was to find that things were just as bad as we'd been saying they were.”

- John F. Kennedy

EXECUTIVE SUMMARY

The value of stock selection skill rises when dispersion is high; a larger gap between winners and losers means that active equity managers have a better chance to display their selection abilities.1  This logic also applies to active managers operating at a higher level of aggregation, for example by expressing tactical market views through sector rotation. The importance of sectors tends to be greater than average during the Novembers when U.S. federal (and especially presidential) elections take place. Sector allocation decisions can add (or subtract) greater value in these months.  British and Canadian data are consistent with the U.S. results.

BACKGROUND

Dispersion, or the index-weighted standard deviation of returns, gives us a convenient way to measure the potential benefit of active decisions.2  Successful active managers—be they stock pickers, sector rotators, or factor investors—can add more value when dispersion is high than when it is low.3  Dispersion also provides a useful framework for understanding the importance of sectors in generating returns.

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Conviction, Confidence, and Courage

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Craig Lazzara

Managing Director, Index Investment Strategy

S&P Dow Jones Indices

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Anu R. Ganti

U.S. Head of Index Investment Strategy

S&P Dow Jones Indices

EXECUTIVE SUMMARY

Never wish to show courage, a wise man once counseled; courage can be displayed only in circumstances where one’s natural instinct is to be afraid, and fear is an unpleasant emotion.  This principle, with obvious qualifications, applies to investment management.  Successful portfolio management can require holding positions when one’s natural instinct is to sell.

ONCE UPON A TIME

It is Dec. 31, 1999.  You are a professional portfolio manager pondering long-term stock selections for your clients.  You share Warren Buffet’s view that “Our favorite holding period is forever,” and you decide to ask each of your four favorite Wall Street forecasters to recommend a stock to hold indefinitely.  They obligingly recommend four different names, denoted for now as Stocks A through D, which you carefully consider.

You’re well aware that some recommendations work out better than others.  What might cause you to lose confidence in any of these four stocks?  Since you will be buying the stocks in the expectation that they will go up, and in fact will outperform the market, a period of disappointing returns might weaken your determination to hold forever.

While contemplating all this, you have been holding a very old bottle of wine that a friend gave you for your last birthday.  You open the bottle, thinking that a taste might help resolve your perplexity.  As you remove the cork, suddenly vapor spews out and a genie emerges.  In gratitude for your having released him, he offers you a wish.

Of course, what you wish is to know which of the four stocks will be the best performer for the next 20 years.  Unfortunately, our genie has been corked up with the wine for a bit too long.  He knows a good bit about volatility but very little about the returns of individual stocks.  The genie does know that the market will go up in the next 20 years, and that individual stock returns will be highly skewed, as Exhibit 1 illustrates.  The median stock in the S&P 500® will appreciate by 52%, well below the average appreciation of 239%.  Only 267 of the 1,010 stocks that will appear in the S&P 500 for the next 20 years will beat the average.

Having been made aware that a relatively small number of stocks will determine your success or failure, you’re happy to have whatever specific information you can get, and ask the genie to tell you what he knows about the four recommendations.

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Fleeting Alpha Scorecard: The Challenge of Consistent Outperformance Year-End 2019

SUMMARY

The Fleeting Alpha Scorecard is a semiannual report showing how well outperforming mutual funds from one three-year period continue to outperform thereafter. It combines two other S&P Dow Jones Indices reports, the SPIVA® U.S. Scorecard and the the Persistence Scorecard. The former measures the percentage of active managers that beat their benchmarks across various equity and fixed income categories. The latter shows the likelihood that strong performers in early periods maintain their status relative to other funds in subsequent periods.

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.

Report 1 shows the performance persistence of managers investing in various domestic and international equity categories, based on trailing three-year returns. Of the 18 categories in domestic equity, eight did not show funds with alpha persistence after three years. For example, as of Dec. 31, 2016, roughly 10% of 313 large-cap value funds had outperformed the S&P 500® Value in the previous three years. By the end of 2019, none of these 31 winners had maintained that status for three consecutive years. Of the winners at the end of 2016, just 12.9% of all domestic equity funds beat the S&P Composite 1500® in each of the three following one-year periods.

The vast majority of domestic equity funds showed little outperformance persistence, with notable exceptions in the small- and mid-cap spaces. Improvement in persistence mainly came from the mid-cap growth funds and the small-cap growth funds, in which 67% and 50%, respectively, of the past winners were able to generate positive alpha in the three subsequent one-year periods (in a small sample size).

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The VIX Index and Volatility-Based Global Indexes and Trading Instruments

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Matt Moran

Vice President of Business Development, Chicago Board Options Exchange (Cboe)

The Cboe Volatility Index® (VIX® Index) measures the market’s expectation of future volatility conveyed by S&P 500 Index option prices. The VIX is recognized as a premier gauge of expected US equity market volatility. The 2000–09 decade experienced two deep bear markets for equities that saw numerous short-term periods of high levels of investor uncertainty. Most investors recall how during the financial crisis of 2008–2009, the correlations between equities rose globally and traditional diversification goals became difficult to achieve. Exchange-listed VIX futures were launched in 2004, and VIX options were launched in 2006. During the 2008–09 financial crisis, VIX futures and VIX options experienced tremendous growth, as interest in and use of such index-based products as exchange-traded notes and exchange-traded funds grew. These products have become widely used in investors’ strategies ranging from trading tactical views on volatility to incorporating volatility trades and hedges in risk management and multiasset strategies.

This study addresses several questions investors have asked related to the VIX Index, volatility-based trading products, and the use of VIX futures in portfolio construction. These questions include the following:

  1. What does the VIX Index measure, and what does a VIX level signify?
  2. What are some indexes that measure expected volatility of European or Asian stock indexes?
  3. How do features such as convexity and negative correlation make the VIX an intriguing investment gauge?
  4. Is the VIX Index tradable, and if not, why?
  5. What tradable volatility-based futures and options products are available?
  6. How do contango and backwardation affect the returns of VIX futures-based strategies?
  7. What volatility benchmark indexes are available, and what is their impact when added to S&P 500 portfolios?

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How Smart Beta Strategies Work in the Australian Market

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Priscilla Luk

Managing Director, Global Research & Design, APAC

S&P Dow Jones Indices

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Liyu Zeng

Director, Global Research & Design

S&P Dow Jones Indices

EXECUTIVE SUMMARY

With increasing interest in smart beta strategies in the Australian equity market, we examined the effectiveness of six well-known risk factors, size, value, low volatility, momentum, quality, and dividends, in the Australian equity market from Dec. 31, 2004, to May 29, 2020.

  • Quintile analysis showed that low volatility, high momentum, and high quality delivered the most persistent absolute and risk-adjusted return spreads, but small cap and value did not generate incremental return in the Australian market.
  • Among the Australian factor indices offered by S&P Dow Jones Indices (S&P DJI), the quality and momentum indices delivered the highest excess returns, while the low volatility and dividend indices had lower volatility than the S&P/ASX 200.
  • Our macro regime analysis showed that most factor portfolios in Australia were sensitive to local market cycles and investor sentiment regimes.
  • The distinct cyclicality of factor performance in Australia indicated its potential for implementation of active views on the local equity market.

How Smart Beta Strategies Work in the Australian Market: Exhibit 1

FACTOR-BASED INVESTING IN THE AUSTRALIAN EQUITY MARKET

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

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

In Australia, although the adoption of factor-based investing by local market participants is behind the U.S. and some Asian markets (like Japan), the growth of factor-based ETPs has accelerated in recent years, achieving 46% growth in net assets in the past 18 months in local currency terms as of Dec. 31, 2018, and accounting for 10.5% of the Australian ETF market. Dividend products still dominate the Australian factor-based ETP market, but we observed the proliferation in categories and the increasing demand for factor-based index-linked products within the Australian equity market.

Based on the performance contribution analysis for the S&P/ASX 200 portfolio, the Financials and Materials sectors contributed about 63.6% of the total performance of the portfolio for more than 15 years.  At a stock level, the top five large-cap contributors (BHP Group Ltd, Commonwealth Bank of Australia, Westpac Banking Corporation, CSL Limited, and Australia and New Zealand Banking Group Limited) together contributed approximately 49% of the total portfolio performance over the same period.  This suggests that sector or size bias might have  a significant impact on the excess return of factor portfolios in the Australian market.

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

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