Incorporating a Minimum Variance Framework into Risk Control 2


A Matter of Degrees: Aligning ESG Strategies with the Paris Agreement

A Guide to S&P Decrement Indices

Indexing Liquid Alternatives

Incorporating a Minimum Variance Framework into Risk Control 2

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Cristopher Anguiano

Senior Analyst, U.S. Equity Indices


In this paper, we introduce the new S&P 500® Futures Daily Risk Control 5% Index (the Risk Control 2 Minimum Variance), which is the latest enhancement to S&P DJI’s Risk Control 1 (RC 1) and Risk Control 2 (RC 2), and a variation on our existing standard RC 2 methodology.[1]

Our risk control techniques began with RC 1, which allocates to equity and cash to achieve a target volatility.  RC 2 then introduced fixed income as another asset class and allocates between an equity and liquid bond index to target a specific volatility.  The bond sleeve in RC 2 is generally a risk reduction tool.  However, in volatile periods when no suitable combination of equity and fixed income is able to attain the target volatility, RC 2 rotates its bond sleeve completely to cash, thereby defaulting to RC 1.

In this new index, we take RC 2 a step further, to RC 2 Minimum Variance.  We allocate to equity and bonds like RC 2; however, unlike RC 2, we introduce cash as an extra alternative rather than a complete swap when underlying volatility picks up.

Incorporating a Minimum Variance Framework into Risk Control 2 Exhibit 1


Though RC 2 takes the RC 1 approach a notch higher by introducing bonds, it still has one shortcoming.  In instances when the volatility target is relatively too low (i.e., during periods of sell-off), the bond sleeve of RC 2 switches completely to cash.

While allocating to cash reduces index volatility, thus bringing it in line with the target, this comes at a cost of higher turnover resulting from this bond-to-cash swap.  Our new optimized approach addresses this problem through its innovative technique and significantly reduces turnover.

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  1. Who is S&P Dow Jones Indices?  S&P Dow Jones Indices (S&P DJI) is home to iconic financial market indicators, such as the S&P 500® and the Dow Jones Industrial Average®. The largest global resource for essential index-based market concepts, data, and research, it is a major investor resource to measure and trade the markets.

    ESG at S&P DJI

    S&P Dow Jones Indices has been a pioneer in environmental, social, and governance (ESG) indexing for 20 years, starting with the 1999 launch of the Dow Jones Sustainability World Index. Today, we offer an extensive range of indices to fit varying risk/return and ESG expectations, from core ESG and low-carbon climate approaches, to thematic and fixed income ESG strategies.

    S&P Dow Jones Indices and SAM, part of S&P Global, have a long history of collaboration since joining forces to launch the world-renowned Dow Jones Sustainability World Index in 1999.

  2. Where does S&P DJI get its ESG data?  S&P Global provides the data that powers the globally recognized Dow Jones Sustainability Indices (DJSI), S&P 500 ESG Index, and others in the S&P ESG Index Series. Each year, S&P Global conducts the Corporate Sustainability Assessment (CSA), an ESG analysis of over 11,000 companies. The CSA has produced one of the world's most comprehensive databases of financially material sustainability information and serves as the basis for the scores that govern S&P DJI's ESG indices.


General Questions

  1. What are the S&P DJI ESG Scores?  S&P DJI ESG Scores are environmental, social, and governance scores that robustly measure ESG risk and performance factors for corporations, with a focus on financial materiality. They are a second set of ESG scores calculated by S&P Global ESG Research, in addition to the S&P Global ESG Scores that are used to define the Dow Jones Sustainability Indices constituents.

    The S&P DJI ESG Scores are the result of further scoring methodology refinements to the S&P Global ESG Scores that result from S&P Global's annual Corporate Sustainability Assessment (CSA), a bottom-up research process that aggregates underlying company ESG data to score levels. The scores contain a total company-level ESG score for a financial year, comprising individual environmental (E), social (S), and governance (G) dimension scores, beneath which there are on average over 20 industry-specific criteria scores that can be used as specific ESG signals (see Exhibit 1).


    A company’s total ESG score is the weighted average of all criteria scores and their respective weights. Each individual ESG dimension score (e.g., a company’s “E” score) is the weighted average of all criteria scores and weights within a specific ESG dimension. Total ESG scores range from 0-100, with 100 representing best performance.

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A Matter of Degrees: Aligning ESG Strategies with the Paris Agreement

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Jaspreet Duhra

Managing Director, Global Head of Sustainability Indices

Having already witnessed some of the consequences of climate change around the world, more and more investors are now factoring ESG into their investment decisions. Enter the S&P PACT™ Indices (S&P Paris-Aligned & Climate Transition Indices), created to give market participants access to strategies designed to be compatible with limiting global warming to 1.5°C.

We talked with Francois Millet, Managing Director and Head of Strategy, ESG and Innovation at Lyxor ETF, and Jaspreet Duhra, Senior Director and Head of EMEA ESG Indices at S&P DJI, about the evolving role of ESG in mainstream investing and how these indices may help market participants envision a less fraught future.

Indexology Magazine: Why do you think ESG investing is becoming more important to investors around the world, and do you think the recommitment to climate initiatives in the U.S. adds to the momentum?

Francois: The pandemic triggered a realization that humans are extremely dependent on natural systems. Many investors now work on the widespread conviction that climate and exponential inequalities are major risks—and that mitigating these risks, and building a more inclusive and resilient world with long-term focus, is a precondition for financial stability.

ESG investments captured more than 50% of net inflows to ETFs in Europe last year. This more than offset the negative influence of the official U.S. position on the Paris Agreement at the time. But it's great to see the U.S., which produces around 15% of the world's greenhouse gas emissions, rejoining the Agreement. This recommitment to climate initiatives should bolster the ESG transformation that's already underway and make the Paris Agreement stronger than ever.

Indexology Magazine: Why were the S&P PACT Indices created, and what specific climate goals do they seek to achieve?

Jas: The world is on a dangerous trajectory of warming that is already impacting society and the economy. Regulators are taking action and as investors increasingly take stock of the climate risks in their holdings, more and more are looking to align their investments with a scenario in which warming increases by no more than 1.5°C. The S&P PACT Indices were created with this goal in mind.

The indices are designed to meet the minimum standards for EU Paris-aligned Benchmarks and EU Climate Transition Benchmarks, which means that in addition to lowering carbon emissions relative to their underlying benchmarks, the indices also seek to decarbonize on an absolute basis at a rate of 7% year-on-year. This is the rate of decarbonization required to achieve net-zero emissions by 2050 and limit warming to 1.5°C according to the Intergovernmental Panel on Climate Change. Interestingly, these indices are also designed to maintain the same exposure to high-climate-impact sectors as their benchmarks, which means the decarbonization can't be achieved by just tipping all the weight into low-climate-impact sectors.

We have also gone beyond the EU Low Carbon Benchmark requirements by aligning with the recommendations of the TCFD (Taskforce on Climate-related Financial Disclosures). We believe that the TCFD approach of breaking climate issues into transition risks, physical risks, and opportunities provides a holistic assessment. It's particularly important that our index takes climate change's physical risks into account, as we already see these risks playing out today.

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A Guide to S&P Decrement Indices

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Izzy Wang

Analyst, Strategy Indices


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.

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Indexing Liquid Alternatives

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Fiona Boal

Head of Commodities and Real Assets

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Phillip Brzenk

Head of Multi-Asset Indices

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Rupert Watts

Senior Director, Strategy Indices


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.

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