IN THIS LIST

A Guide to S&P Decrement Indices

Indexing Liquid Alternatives

Talking Points: Capturing the Growth of the Australian Technology Industry

The S&P 500 ESG Index: Defining the Sustainable Core

The S&P/B3 Brazil ESG Index: A New Benchmark for Sustainability and Investment

A Guide to S&P Decrement Indices

Contributor Image
Tianyin Cheng

Senior Director, Strategy Indices

Contributor Image
Izzy Wang

Analyst, Strategy Indices

INTRODUCTION

Decrement indices have gained popularity as the underlying assets of equity-linked structured products in Europe and Asia. According to Structured Retail Products, among the 318 products across asset classes in France that matured or autocalled between April 2018 and March 2019, more than 32 were linked to decrement indices.

One of the reasons behind this recent popularity is the low interest rate environment that has emerged since the 2008 Global Financial Crisis, which has posed challenges for structured product issuers to design attractive products. This environment triggered a search for new underlying assets or strategies that might deliver cheaper optionality. Decrement indices aim to provide a solution to this challenge. S&P DJI has developed a flexible, transparent, and rules-based decrement index framework, which features:

  • Globally accepted, independent underlying indices such as the S&P 500®;
  • Transparent methodology based on the S&P DJI decrement framework; and
  • Customization options in underlying index and decrement parameters.

Exhibit 1

How Decrement Indices Work

A decrement is an overlay applied to an underlying index. It is constructed by periodically deducting a predefined fee, either in the form of a fixed percentage or index points, from the underlying index (see Exhibit 1).

Given an underlying index, decrement indices can be calculated in different ways, depending on which parameters are chosen (see Exhibit 2). All the parameters can be customized. Decrement type and application are the most important parameters, as they primarily determine the amount of decrement deduction and how it is applied to an underlying index.

Exhibit 2


Decrement Type

The performance reduction applied to an underlying index can be either fixed percentage or fixed point. The logic of the fixed-percentage decrement is that dividend yield tends to be stable over the long term. During the past 10 years, the trailing 12-month dividend yield for the S&P 500 was relatively stable, at about 2%. On the other hand, a fixed-point deduction assumes a relatively high level of stability in dividend amounts in the short term, as companies are inclined to maintain more stable dividend policies compared with their earnings.

pdf-icon PD F Download Full Article

Indexing Liquid Alternatives

Contributor Image
Tianyin Cheng

Senior Director, Strategy Indices

Contributor Image
Phillip Brzenk

Senior Director, Strategy Indices

Contributor Image
Rupert Watts

Senior Director, Strategy Indices

Contributor Image
Fiona Boal

Head of Commodities and Real Assets

INTRODUCTION

Alternative investment strategies, including absolute return long-short, risk parity, global macro, or relative value, have historically been used only by the most sophisticated market participants, such as institutional investors and hedge funds.  Market participants often seek alternative investments to improve diversification in portfolios, since these strategies tend to exhibit low correlations to the more traditional financial market asset classes of equities and fixed income.  Better diversification may lead to higher risk-adjusted returns and lower drawdowns in a portfolio relative to one that only holds stocks and bonds.

However, a drawback of some alternative investments is that they can be relatively illiquid and only appropriate for long-term investment horizons without short-term liquidity needs.  Conversely, investing in alternative strategies through liquid instruments, such as exchange-traded futures contracts, can reduce the illiquidity risk, making them a good fit for a broader range of market participants.  These strategies, commonly referred to as liquid alternatives, give market participants better access to alternative investments.  Additionally, liquid alternatives in an index format provide a systematic rules-based methodology, transparency in pricing, and typically lower cost structure.

There is a wide range of liquid alternative strategies with differing characteristics or key properties as the underlying rationale for construction.  A liquid alternative strategy could vary from directional to market neutral to trend following.  Directional strategies are typically long-only with low-to-moderate correlation to broad equities, seeking higher risk-adjusted returns relative to the market over the long term.  Market-neutral strategies seek to provide purer exposure to certain risk premia in the marketplace by stripping out the market beta.  These are typically long-short and target a zero beta, and thus tend to exhibit a low correlation to broad equities.  A trend-following strategy seeks to capture price trends by going long or short different assets based on recent price movements, and its correlation to broad equities varies from positive to negative over time.  To have a large opportunity set and proper diversification, a trend-following strategy often incorporates multiple asset classes, such as equities, fixed income, currency, and commodities.

pdf-icon PD F Download Full Article

Talking Points: Capturing the Growth of the Australian Technology Industry

Contributor Image
Michael Orzano

Senior Director, Global Equity Indices

The S&P/ASX All Technology Index highlights a unique and innovative segment of the Australian market.

  1. Why was this index introduced?

In recent years, ASX-listed technology companies have experienced substantial growth in terms of both number of companies and market capitalization. In the past six years, the number of S&P/ASX All Technology Index constituents nearly tripled from 24 to 69, while the total market capitalization of these companies increased tenfold from AUD 17 billion to about AUD 170 billion.

In a market heavily concentrated in banks and natural resource companies, there is significant demand for an index that captures the Australian technology sector in a comprehensive yet precise way. Importantly, the technology segment measures a unique, innovative part of the market that remains a small portion of the broader Australian share universe. We also expect the index to increase the visibility of technology-related businesses listed on the ASX, which should support further growth of the sector over time.

pdf-icon PD F Download Full Article

The S&P 500 ESG Index: Defining the Sustainable Core

Contributor Image
Daniel Perrone

Director and Head of Operations, ESG Indices

Contributor Image
Reid Steadman

Managing Director, Global Head of ESG

Contributor Image
Margaret Dorn

Senior Director, ESG Client Engagement North America

Contributor Image
Mona Naqvi

Head of ESG Indices, North America

The launch of the S&P 500 ESG Index in April 2019 signaled an evolution in sustainable investing.  Indices based on environmental, social, and governance (ESG) data were no longer simply a means for companies to declare their sustainability credentials or tools to manage tactical investments playing a minor role in investors’ portfolios.  The S&P 500 ESG Index and other such indices were built to underlie strategic, long-term mainstream investment products.

For decades, the prospect of inclusion in ESG indices like the Dow Jones Sustainability Indices has encouraged companies to manage their businesses with various stakeholders and objectives in mind.  However, these pioneering, best-in-class indices tended to be narrow, including only a small selection of the top ESG performers.  This presented challenges to individual and institutional investors who were concerned about the risks inherent in highly concentrated portfolios defined by these indices.

The S&P 500 ESG Index addressed the need for an index that incorporates ESG values while offering benchmark-like performance.  Intentionally broad—including over 300 of the original S&P 500 companies—the S&P 500 ESG Index reflects many of the attributes of the S&P 500 itself, while providing an improved sustainability profile.  

This paper outlines the characteristics of the S&P 500 ESG Index that have appealed to investors, including:

  • The easy-to-understand methodology behind the index;
  • How “financial materiality” drives index construction;
  • The similar risk/return profiles of the S&P 500 ESG Index and the S&P 500;
  • How the ESG characteristics of the S&P 500 ESG Index are improved compared with those of the S&P 500; and
  • Specific examples demonstrating how the S&P 500 ESG Index methodology sorts and selects companies.

pdf-icon PD F Download Full Article

The S&P/B3 Brazil ESG Index: A New Benchmark for Sustainability and Investment

Contributor Image
María Sánchez

Associate Director, Global Research & Design

Contributor Image
Reid Steadman

Managing Director, Global Head of ESG

Contributor Image
Laura Assis Iragorri

Analyst, Global Research & Design

S&P Dow Jones Indices

INTRODUCTION

Indices that integrate environmental, social, and governance (ESG) data are moving from the margins to the mainstream, as investors increasingly seek to align their values with their investments. A new type of ESG index is emerging to facilitate this change in Brazil: the S&P/B3 Brazil ESG Index. Jointly developed by S&P Dow Jones Indices (S&P DJI) and the Brazilian stock exchange (Brasil Bolsa Balcão [B3]), this index not only highlights strong ESG companies—as ESG indices have traditionally done—but it also enables allocation to such companies without requiring investors to take on major risks relative to the market.

THE EVOLUTION OF ESG INDICES

In 1999, S&P DJI launched the first global ESG index, the Dow Jones SustainabilityTM World Index (DJSI World). By including the top 10% of companies, industry by industry, according to their ESG performance, as determined by the Corporate Sustainability Assessment (CSA) conducted by SAM, part of S&P Global, this groundbreaking index encouraged companies to incorporate many ESG factors in their decisions, extending beyond short-term financial considerations.

In the years that followed, other indices, including regional versions of the DJSI World, such as the DJSI Emerging Markets, were launched with this same philosophy in mind: to highlight best-in-class companies and thereby inspire companies to improve their ESG approaches in order to qualify for inclusion in these indices.

Though these indices have been successful and have indeed inspired companies to change in positive ways, aspects of their methodologies present challenges for many investors. Some strategies can be too narrow for investors who want to remain broadly diversified. Though many high-conviction investors use the narrow, best-in-class indices for investment, we saw a need from market participants for ESG indices with returns more in line with the broader market, while providing a more sustainable portfolio of companies. An example of an index that launched in 2019 that typifies this investor-oriented methodology is the S&P 500® ESG Index.

With the launch of the S&P/B3 Brazil ESG Index, Brazil now has an investor-oriented ESG index of its own. This index maintains a large portion of the companies in its underlying index, the S&P Brazil BMI, thereby staying broad and diverse while still screening out companies involved in certain business activities and controversies, as well as those with sustainability profiles that run counter to ESG investors' preferences.

HOW THE INDEX WORKS

The philosophy behind the S&P/B3 Brazil ESG Index is to maintain broad market exposure while aligning with the values of sustainability-focused investors.

The first step is to exclude companies involved in certain business activites contrary to general ESG values. For companies involved in tobacco, controversial weapons, and thermal coal, certain maximum revenue thresholds are set, as defined in the index methodology. If a company generates revenue exceeding these thresholds, it will be excluded at the annual index rebalance that takes place the last business day of April each year. Companies with business practices out of alignment with the United Nations Global Compact (UNGC) are also excluded at the annual rebalance. The exclusion criteria used in Step 1 are provided by Sustainalytics.

Once these exclusions are implemented, an additional screen is applied: companies without S&P DJI ESG Scores are eliminated. Once this is done, the list of companies eligible for the sorting and selection process has been defined.

The remaining companies are then weighted by their ESG scores, subject to certain weighting constraints defined in the methodology. This way, while companies with poor ESG scores can be included, they are given a low weight in the index.

pdf-icon PD F Download Full Article

Processing ...