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Improving the 60/40 Policy Benchmark: Diversifying Within Equity Allocations

FAQ: DJIM Target Risk Indices

15 Years of SPIVA®, the De Facto Scorekeeper of the Active vs. Passive Debate

Can Dividends Yield a Better Retirement?

S&P/TSX Geographic Revenue Exposure Indices: Where’s Your Exposure?

Improving the 60/40 Policy Benchmark: Diversifying Within Equity Allocations

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Tianyin Cheng

Senior Director, Strategy Indices

Asset owners are faced with a number of external drivers, which may have important consequences for their asset allocation.  Among these, low central bank rates, low discount rates/higher liabilities, lower expected returns across many asset classes, and potentially important downside risks may be the most influential.  Moreover, despite concerns about potentially full valuations for listed equities following recent strong performance, asset owners still typically rely on this asset class to provide the bulk of return generation, given the greater scalability and relatively lower cost of access.[1]

This paper will demonstrate the potential investment efficiency improvement to the equity component of a traditional policy benchmark of 60% market-cap-weighted equities and 40% value-weighted fixed income. We explore how the risk-adjusted return characteristics of various combinations of non-market-cap-weighted and thematic equity indices might provide a more balanced exposure to listed equities.  The alternatives to market-cap-weighted equity indices we considered include: a multi-factor quality, value, and momentum index; equal-weighted indices; low volatility and minimum volatility indices; dividend indices; listed private equity; listed infrastructure; and listed real estate indices. 

In upcoming research papers, we will explore differentiation opportunities versus the traditional fixed income policy benchmark and index-based approaches to access alternative strategies like volatility, carry, and commodities.

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FAQ: DJIM Target Risk Indices

Multi-Asset, Shariah-Compliant Indices for Global Investors

The Dow Jones Islamic Market (DJIM) Target Risk Indices are a series of multi-asset benchmarks that combine core equity, sukuk, and cash components, allowing market participants to choose an allocation framework that best reflects their investment style.

  1. What role do the DJIM Target Risk Indices serve in the market? Use of multi-asset, Shariah-compliant benchmarks has increased significantly in recent years, as Islamic market participants have sought tools to manage risk while generating growth and income.  Each index in this series combines core equity, sukuk, and cash components in differing predefined allocations in order to target various risk/return profiles.  The indices can serve as performance benchmarks for multi-asset, Shariah-compliant funds or as underlying indices for passive investment vehicles.

  2. How do the indices work? The DJIM Target Risk Indices combine various equity indices, the Dow Jones Sukuk Index, and a cash component at fixed allocations.  Each series consists of five indices, each targeting a different risk profile (see Exhibit 1).

    The index weights are reset to the fixed allocations on a quarterly basis, effective after the close of the third Friday in March, June, September, and December—coinciding with the rebalancing schedule for the Dow Jones Islamic Market Indices.

  3. How are the equity allocations composed? Beyond asset-class target allocations, the DJIM Target Risk suite offers flexibility to users with varying approaches to the equity allocation.  The DJIM Target Risk Series offers a global, market-cap-weighted approach, using developed and emerging market equity indices, as well as the Dow Jones Sukuk Total Return Index (exReinvestment), as shown in Exhibit 2.

A second approach, the DJIM Target Risk (Fixed Allocation) Series, fixes weights between equity components in order to better reflect the typical investment style of U.S.-based investors, while offering further granularity within U.S. equity subsets.  Regional equity allocations are fixed at 70% U.S. and 30% international.  Exhibit 3 illustrates the full allocation of each component index within the series.  There is also a U.S. subset of the fixed allocation series that excludes non-U.S. equity.  Each series uses the Dow Jones Sukuk Total Return Index (exReinvestment) in order to reflect exposures to global Shariah-compliant fixed income and allocates to cash in order to further reduce volatility.

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15 Years of SPIVA®, the De Facto Scorekeeper of the Active vs. Passive Debate

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Aye Soe

Managing Director, Global Head of Product Management

Few people know the ins and outs of the SPIVA (S&P Indices Versus Active) Scorecard better than Aye Soe, Managing Director of Research & Design. A few months after SPIVA’s 15th birthday, Emily Wellikoff, Indexology Magazine Editor-in-Chief, sat down with her to discuss how the report has grown over the last decade and a half, its most surprising findings, and what’s changed since factor investing started blurring the lines between active and passive.

EMILY: Fifteen years, or one-and a-half market cycles, since SPIVA launched, what’s the most important lesson you’ve learned about active and passive investing?

AYE: The most important thing we’ve learned is that the average manager hasn’t been able to beat the benchmark across most equity and fixed income categories over the long term. There may be a small number of managers who are able to beat the benchmark in any given year, but the likelihood of those managers repeating the same success consistently in the years that follow is small, less than a random coin toss.

EMILY: What are some common misconceptions or myths about the active versus passive debate that you have come across in the last 15 years?

AYE: In equities, many people see small-cap and emerging markets as areas where market inefficiencies may provide opportunities for active management. However, near-, mid-, and long-term results for the two categories show that average active managers do not necessarily fare better than their benchmarks. In fact, over 1-, 3-, 5-, and 10-year periods, the majority of active managers in those two categories have overwhelmingly underperformed. Market inefficiency may exist in those asset classes, but the results dispel the myth that an average active manager has historically been able to deliver higher relative returns than the benchmark.

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Can Dividends Yield a Better Retirement?

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Howard Silverblatt

Senior Index Analyst, Product Management

This piece originally appeared in the December 2017 edition of Indexology Magazine.

If you're getting up there in age, as I am, you are looking to eventually retire. And while that does not necessarily mean you will stop working, it does likely mean a reduction in current and expected income. It also means needing to live on what you will now be generating and protecting that income and principal.

Looking for income in today’s lowrate environment, where the Fed has increased rates twice this year and is expected to do so one more, is a relatively poor search, as interest rates have actually declined yearto-date (the 10-year is at 2.30%, compared to 2.45% at year-end 2016 and 2.27% at year-end 2015). While some bank instruments have inched up, it is not enough to change the risk/reward tradeoff, as they remain uncompetitive with yields, especially given the reduced tax treatment of qualified dividends. Bonds yields are competitive, but with no tax advantage, and unless you are able to hold them until maturity, higher interest rates could erode your principal if you need to sell them; additionally, fixed rate instruments do not necessarily move up with interest rates. Preferred issues also tend to have a higher yield, but their rate may not be impacted by interest rates increases, with most not having a tax advantage. In the current environment, income seekers have very few choices, with dividends having very little in the way of competition, which could be adding to their lower growth rate. Adding to the current dividend bandwagon is the market, where the aging bull continues on, setting new highs, and companies slowly play catch-up with their yields, which have declined as prices outpaced dividend increases.

The way I look at it, dividends could become my “paycheck” in retirement, and while pay raises are nice, the paycheck needs to continue to come in, even without the raise. That means I could look to companies with a history of paying and increasing dividends, as well as sufficient earnings and cash flow (can’t write a check against proforma earnings) from current operations to cover the dividend and grow the business. The company doesn’t have to do great or even set records, but they do need to have a stable product line that I am comfortable with going forward, and the potential upside of longer-term capital appreciation (so they can increase the dividend).

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S&P/TSX Geographic Revenue Exposure Indices: Where’s Your Exposure?

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John Welling

Director, Equity Indices

Our geographic revenue exposure indices target Canadian or U.S. markets by capturing the performance of S&P/TSX 60 companies with revenues that center on these countries. The top one-half of those companies with the highest proportion of revenues within the target region are selected for inclusion within the relevant index. Constituents are then weighted by float market cap times the revenue exposure score. By creating the S&P/TSX 60 Canada Revenue Exposure Index, we are able to increase exposure to Canadian-centered companies, delivering an index that is designed to provide comparably higher exposure to Canadian-based revenues. Likewise, the S&P/TSX 60 U.S. Revenue Exposure Index shifts focus toward companies with U.S.-centered revenues.

Sector weight and composition differences have contributed to performance differences within each index and include the following.  

  • The domestic revenue nature of Canadian banks tilts the financials sector weight away from the U.S., while Brookfield Asset Management somewhat offsets this due to the nature of its foreign- and U.S.-based revenues.
  • Telecommunication services companies (primarily BCE Inc.) generate a majority of their revenues domestically, favoring exposure to Canada.
  • Materials companies gain a higher proportion of revenues from within the U.S.
  • Exploration- and production-focused energy companies generate more revenues within Canada, whereas revenues from pipeline companies are skewed toward the U.S.
  • Notably, currency fluctuations, including CAD or USD strengthening or weakening, affect the value of Canadian exports when domestic companies earn revenues in foreign currencies and convert these back into Canadian dollars.

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