IN THIS LIST

ESG Investing in U.S. Investment Grade Credit

TalkingPoints: A Practical Look at Index Liquidity in Asia

Introducing the iBoxx USD Liquid Investment Grade BBB 0+ Index

Defensive Strategies for the Asian USD High Yield Credit Market

TalkingPoints: Finding Resilience amid Uncertainty: A Low Volatility High Dividend Approach for the A-Share Market

ESG Investing in U.S. Investment Grade Credit

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Nicholas Godec

Head of Fixed Income Tradables

S&P Dow Jones Indices

Introduction

Assets tracking ESG-based investment strategies have been booming recently. While ESG demand has increased in recent years, there’s been additional appetite in the wake of the COVID-19 pandemic. ESG refers to three key aspects of sustainability and ethical business practices: environmental, social and governance.  When measured and filtered for, ESG-based investing can provide a way for capital to flow to firms that engage in business lines and practices conducive to sustainability and high standards of ethics.  Much in the way investors have long understood risk factors related to credit, interest rates and idiosyncrasies, ESG metrics seek to capture real risk factors facing investors.

With the launch of the iBoxx MSCI ESG Advanced USD Liquid Investment Grade (IG) Index (IBOXIG ESG), the U.S. IG corporate bond market has a crucial measure for the tradable ESG IG credit market.  The IBOXIG ESG selects from the iBoxx USD Liquid Investment Grade Index (IBOXIG) universe, and then applies climate and values-based screens to create an index composed of the IBOXIG entities with above-average ESG scores relative to their industry peers.  The ESG screens exclude flagged business lines, as well as firms where the percent of revenue is linked to flagged business practices.

The climate-based screens remove issuers from the Oil & Gas sector, issuers with industry ties to fossil fuels and issuers scoring below a defined threshold for environmental controversy.  The values-based screens remove a variety of controversial business activities including adult entertainment, alcohol, civilian firearms, controversial weapons, privatized prisons, gambling, genetically modified organisms, nuclear power, nuclear weapons, palm oil, predatory lending and tobacco, as well as issuers violating the United Nations Global Compact (UNGC).  The index also removes issuers with MSCI ESG ratings of BB and below and issuers below a defined threshold for overall controversy.

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TalkingPoints: A Practical Look at Index Liquidity in Asia

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Izzy Wang

Analyst, Strategy Indices

What role does index liquidity play in helping market participants in Asia participate in the U.S. equity ecosystem during Asia’s trading hours?

1. What are the key differences between the S&P 500® and Dow Jones Industrial Average® (DJIA®) and why do liquidity and trading volumes that are tied to these indices matter?

Izzy: The S&P 500 and DJIA are widely used gauges of U.S. large-cap equity performance. They contain many of the largest companies in the world, and the indices also underlie many of the investment products like exchange traded funds, index funds and derivatives, futures and options.

One key difference between the two indices is the weighting approach. The Dow® is price weighted, whereas the S&P 500 is the market-cap weighted. The number of constituents is also significantly different—30 for The Dow versus 500. Note also that there are no utilities or transportation companies contained in The Dow, as they are tracked separately by the Dow Jones Utility Average and Dow Jones Transportation Average.

I think we often hear about how much assets have been growing, tracking passive product index profiles in the news or media. However, there is little transparency and emphasis on the liquidity and trading volume of these products. This is unfortunate, because volume can give us a good indication of how well these products are policed by arbitrages. For example, when buying and selling, investors rely on arbitrages to make sure that ETFs are in line with the underlying index members.

When there is a market sell-off and liquidity becomes a big issue, will an ETF still be able to be sold with a price close enough to the underlying stock members? And this is when market efficiency becomes important and why indices with large ecosystems and liquidity are especially relevant. Both the S&P 500 and DJIA have a decade-long record of attracting liquidity, and they have proved of interest to arbitrages and media.

2. How do our indices tracking the S&P 500 and DJIA futures compare with other Asian headline indices underlying futures contracts? For Asian investors, why are those differences important to consider?

Izzy: The key potential advantage of having U.S. benchmark futures trade during Asian hours is for investors to transact in local time zones. The potential use case is for investors to react to market news as it happens and hedge against events that happen during Asian hours. They could also potentially adjust their positions ahead of economic releases and announcements. To achieve these potential benefits, the liquidity and bid-ask spread during Asian hours is important.

We have also done our own research in comparing the S&P 500 and DJIA versus Asian equity indices. From the angle of futures trading, we found the Asian hours liquidity of S&P 500 futures has been growing at a 13% 10-year CAGR. For The Dow, the growth rate is even higher, at 17%. Just to compare, the liquidity of S&P 500 futures has also been close to futures on the Nikkei and Hang Seng Index, which speaks to the potential use case.

The co-movement between the U.S. and Asian markets is another interesting point to consider. Co-movement is measured by correlation, with close-to-close daily return as its basis. However, such an approach may underestimate correlations between the U.S. and Asian markets because there is a difference in the trading hours. With futures trading now almost 24 hours a day, we are able to measure correlation with the same cut-off time during the day. If we do correlation in this more correct way, we see that the futures on U.S. benchmarks had meaningful correlation with Asian benchmarks, especially during crisis periods.

3. How do you define liquidity and what role does liquidity play in helping you to manage your own strategies?

Jean-Francois: Liquidity can indeed play a critical role in investors' portfolios. Looking at ETFs for example, there are several layers of liquidity available to institutional investors. The first one would be the liquidity on exchange, where investors can trade against each other. In that case, large trading volumes as well as low bid-ask spreads would be indicators of good on-exchange liquidity.

The second and third layers of liquidity for ETFs relate to the ability of investors to trade OTC and to leverage the underlying liquidity in the market by benefiting from the creation/redemption mechanism of ETFs. For example, if an investor were to purchase a large amount of ETF units in one trade, and they don’t find enough depth available on an exchange, they may still be able to trade OTC against specialized counterparties. These specialized counterparties, sometimes authorized participants, then meet this outsized demand by creating additional ETF units in the primary market. In short, ETFs are always at least as liquid as their underlying market, which is why the index they track really matters in terms of the overall liquidity.

If the primary market is liquid, then it helps to increase the liquidity in the secondary market. In addition, we have also seen synergies between different vehicles like ETFs and futures tracking the same indices when sophisticated market participants are leveraging the liquidity of ETFs and futures for their arbitrage activities.

4. How are Asia-based investors using indices to help track potential opportunities in U.S. markets?

Jean-Francois: We see through ETFs a number of different usages. Especially last year during the period of increased volatility in the U.S. with the beginning of the COVID-19 pandemic, we saw a number of investors doing tactical trends and sometimes overnight trading, trying to benefit from discrepancies and market movements between Asian hours and U.S. market hours. While we have seen that type of activity happening, we also see the classic buy and hold within the traditional asset allocation framework used by institutional investors in the region. So really, the usage in terms of ETFs tracking the S&P 500 or the DJIA is broad.

Of course, I'm talking about traditional buy-side investors, but there is also an entire crowd of index arbitragers, market makers and liquidity providers that use these ETFs for other purposes. The second part that I think is also important to highlight is we see more and more investors trading during Asian hours. There is a potential time risk by waiting for the U.S. to open, so they make use of the ability to trade ETFs tracking the S&P 500 and the DJIA during Asian hours in order to not be caught by market movements overnight.

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Introducing the iBoxx USD Liquid Investment Grade BBB 0+ Index

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Nicholas Godec

Head of Fixed Income Tradables

S&P Dow Jones Indices

Executive Summary

The iBoxx USD Liquid Investment Grade BBB 0+ Index seeks to track the BBB segment of the investment-grade (IG) universe.  As the IG universe has evolved in the past few years, the launch of this index comes at an opportune time for the following reasons:

  • The BBB rated segment of the USD IG corporate bond market is the largest segment of the IG credit markets, at 50% of the notional outstanding. It has become increasingly important for IG debt investors looking for incremental yield and risk exposure;
  • Further, BBB rated debt has outperformed the broader IG market on a risk-adjusted return basis;
  • BBB rated debt can offer a pickup in yield; and
  • Incorporating a basis of investment that targets the investable BBB rated segment of the USD IG bond market could help refine exposure and grant greater flexibility in positioning.

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Defensive Strategies for the Asian USD High Yield Credit Market

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Kangwei Yang

Director, Fixed Income Product Management

S&P Dow Jones Indices

Market Overview (2021-Present)

International investors have long viewed the Asian USD high yield credit bond market as an alternative investment universe to the traditional U.S. high yield market. As a result, the junk bond market has undergone considerable growth, with the total issuance increasing almost sixfold between 2012 and 2020.

However, the market has seen some turbulence in the past 12 to 18 months, largely due to its high exposure to the Chinese real estate market. In the past decade, Chinese real estate companies have issued large amounts of debt at a low borrowing cost to fund their operations. This changed when Chinese regulators imposed new rules to deleverage the financial system. Meanwhile, companies were unable to turn over their inventory effectively for cash, and a liquidity crisis in the sector began to emerge.

In September 2021, China Evergrande Group, the second-largest property developer in China by sales, missed coupon payments on its U.S. debt obligation. Since then, there has been a growing list of prominent names involved in the Chinese real estate sector crisis. The top five issuers by market value as of April 2021 in the iBoxx USD Asia ex-Japan China High Yield Real Estate2 have defaulted on their USD debt obligations in the past 12 months.

As of May 31, 2022, more than 12 distinct Chinese property issuers in the iBoxx USD Asia ex-Japan Corporates High Yield had missed payments on their U.S. debt, and the total amount of issuance removed from the index exceeded USD 35 billion.

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TalkingPoints: Finding Resilience amid Uncertainty: A Low Volatility High Dividend Approach for the A-Share Market

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Izzy Wang

Analyst, Strategy Indices

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Jason Ye

Director, Strategy Indices

The S&P China A-Share LargeCap Low Volatility High Dividend 50 Index is designed to offer liquid and tradable exposure to dividends  and low volatility, two well-known risk factors that have delivered risk premium in the China A-share market in the past.

The two factors are combined through sequential dividend and low  volatility screens. Companies exhibiting high dividend yield may fall in a “dividend trap,” since high dividend yield can be caused by decreasing stock prices rather than increasing dividend payments. Overlaying a low volatility screen on a high dividend portfolio may help to eliminate the dividend trap, resulting in improved absolute and risk-adjusted returns.

Over the 10-year back-tested period, the index has shown robust return, lower risk, reduced drawdown, and cheaper valuation than its benchmark. The index may be appealing to those who wish to maintain equity exposure but limit risk or those who are interested  in increasing equity exposure without increasing risk.

Uncertainty has been a common theme throughout 2019 and rolling into 2020, with escalated risk of Covid-19. The S&P China A-Share LargeCap Low Volatility High Dividend 50 Index may help to provide an alternative for investors to ride through this challenging period.

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