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Effective Scoring to Capture Quality and Value in China

From Zero to Hero: The Indian Case for Global Equity Diversification

A Survey of Mexican Insurance Investment Officers - H2 2020

Indexing Risk Parity Strategies

ETF Transactions by U.S. Insurers in Q2 2020

Effective Scoring to Capture Quality and Value in China

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Priscilla Luk

Managing Director, Global Research & Design, APAC

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Liyu Zeng

Director, Global Research & Design

In the S&P China A Quality and Value Indices, various financial ratios are combined to form the respective factor scores. In this paper, we evaluate two methods used to normalize and combine the financial ratios—z-scores and SNDZ-scores1 —on how they resulted in different portfolio characteristics for quality and value in the China A market from 2006 through 2019.

EXECUTIVE SUMMARY

  • Equal-weighted quality and value subfactor z-scores resulted in unbalanced subfactor portfolio tilts and biased subfactor contribution to final scores.
  • When applying the equal-weighted z-scores approach, the quality portfolio was dominated by the accruals factor in its portfolio tilts and factor score contribution.
  • The quality portfolio based on the subfactor SNDZ-scores had more balanced and consistent tilts to various quality subfactors and a reduced number of stocks with low return-on-equity (ROE) and high leverage (LEV) ratios.
  • The SNDZ-score approach resulted in more all-around high-quality stocks that scored well across various quality measures.
  • Quality portfolios based on two different scoring methods had similar performances over the long-term history, with opposite performance cyclicality behavior.
  • The quality portfolio based on z-scores had procyclical performance characteristics while the one based on SNDZ-scores behaved defensively.
  • When using SNDZ-scores, the quality portfolio had higher sector bias in defensive sectors, including Health Care and Consumer Staples.
  • The quality portfolio based on SNDZ-scores had higher active exposures to profitability and low LEV. ROE attributed most to the active return and risk among all style factors.
  • Portfolio characteristic differences in value portfolios based on two different scoring methods are negligible.

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From Zero to Hero: The Indian Case for Global Equity Diversification

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Tim Edwards

Managing Director, Index Investment Strategy

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Koel Ghosh

Head of South Asia

Until quite recently, Indian investors have had good reason to ignore global equities: from 2003 to 2018, India delivered the best returns out of any of the world’s 40 largest stock markets.1  Further deterring their interest, access to international markets has not always been easy or cheap. 

However, times are changing. During the COVID-19 pandemic, global markets found new champions in industries without close Indian equivalents, while Indian investors began showing interest in new, simpler routes to international diversification such as mutual funds and exchange-traded funds (ETFs).

By offering low-cost options to diversify, index-based investing has seen significant growth in other global markets, and 2020 brought India up to date with the first fund tracking the S&P 500®, which is perhaps the world’s most widely recognized equity benchmark. Soon, investors in India may be offered a range of options tracking indices for more global regions, global sectors, and even indices reflecting investment targets such as income, growth, or ethical investing.

Using the long histories of benchmarks and fund performance data published by S&P Dow Jones Indices (S&P DJI), this paper examines the arguments and opportunity set for index-based international diversification from an Indian perspective, with a focus on the practical impact of an allocation to global equities.

HOME BIAS IN INDIAN EQUITIES

We cannot know, down to the last Indian rupee or U.S. dollar, how much all Indian investors own in all international stocks. According to some academic estimates, the average allocation made to international equities by Indian investors is one of the lowest of any country, only a rounding error away from 0%2. Meanwhile, the distribution of AUM across the Indian mutual fund market supports the hypothesis that Indian investors have been almost exclusively domestically focused.

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A Survey of Mexican Insurance Investment Officers - H2 2020

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Raghu Ramachandran

Head of Insurance Asset Channel

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Kelsey Stokes

Associate Director, Marketing

OVERVIEW

In early 2020, S&P Dow Jones Indices and the Association of Mexican Insurance Companies (AMIS) conducted our second annual survey of insurance investment officers in Mexico to gather their perspectives on investments and the state of the local insurance industry. The survey closed at the end of February 2020, just before COVID-19 had begun to rapidly spread throughout North America.

Because of this, we felt it necessary to administer the survey again, this time in the second half of 2020, to better gauge investors' sentiments as they adjust to their "new normal." The objective of this survey was to better understand Mexican insurers' perspectives on the investment landscape, how companies invest and allocate their excess capital, and how their outlook and allocations may have changed in light of COVID-19.

This report summarizes insurers’ views on the following topics:

• Investment concerns and risks;
• Economic and credit rating expectations for the remainder of 2020;
• Investments and asset allocation, with a focus on excess capital; and
• Investment trends, including ESG and passive investing.

INVESTMENT CONCERNS AND RISKS

One of the most significant shifts the H2 2020 survey results highlighted was in insurers' investment concerns. Respondents indicated their level of worry—very worried, somewhat worried, not worried, and no opinion—about a number of investment-related risk factors. The number of risk factors they classified as very or somewhat worrying increased from 59% in H1 2020 to 72% in H2 2020.

While insurers were more concerned overall about a range of risks, the nature of which risks were most concerning also shifted. Exhibit 1 shows the frequency with which respondents described a risk as very worrying; risk factors like the credit cycle, a global recession, and market volatility, which were previously of lesser concern, now appeared to be more top of mind.

At the beginning of 2020, insurers were most concerned about political risk or corruption, generating returns, and the sustained low interest rate environment—only 16% of respondents cited low interest rates as their chief concern. The most recent data, however, tells a different story; 41% of respondents cited the sustained low interest rate environment as their greatest concern, followed by the threat of a global recession and inflation (see Exhibit 2). Additionally, insurers' three greatest concerns from 2019—political risk or corruption, regulatory uncertainty, and generating returns—were not among respondents' chief concerns in H2 2020.

Insurers' shifting concerns illustrate the impact COVID-19 has had; this impact also appears in respondents' outlook on credit ratings, asset allocation, and expected returns.

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Indexing Risk Parity Strategies

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Berlinda Liu

Director, Global Research & Design

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Tianyin Cheng

Senior Director, Strategy Indices

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Phillip Brzenk

Senior Director, Strategy Indices

INTRODUCTION

The S&P Risk Parity Index Series provides a transparent, rules-based benchmark for equal-risk-weighted parity strategies.  These indices construct risk parity portfolios by using futures to represent multiple asset classes and the risk/return characteristics of funds offered in the risk parity space.  Because risk parity funds can have different volatility targets, our series consists of four indices with different target volatility (TV) levels: 8%, 10%, 12%, and 15%.

Modern Portfolio Theory (MPT), introduced by Harry Markowitz in 1952, sets the framework for market participants to potentially maximize portfolio returns for a given level of risk.  The theory favors portfolio diversification by holding non-correlated assets.  That is, it does not view individual asset returns and volatilities in isolation; rather, it takes into account the co-movements, or correlations, of asset returns that comprise a portfolio.

The theory, along with the expectation that long-term asset class Sharpe ratios are similar (Dalio et al., 2015), act as foundational pieces of risk parity. Risk parity strategies propose that portfolio diversification, defined as achieving the highest return per unit of risk, can be maximized when a portfolio’s assets contribute equally to total portfolio risk.

Since the launch of the first risk parity fund, Bridgewater's All Weather Fund in 1996, many asset managers have offered their version of risk parity to clients. The risk parity industry especially gained traction in the aftermath of the 2008 global financial crisis, growing to an estimated USD 150-175 billion at year-end 2017 according to the IMF (Antoshin et al., 2018).

In the past, such strategies lacked an appropriate benchmark, leaving most investors to benchmark against a traditional 60/40 equity/bond portfolio. The problem with this approach is that a 60/40 portfolio reflects neither the construction nor the risk/return characteristics of risk parity strategies. While portfolio risk is generally considered to be diversified in U.S. dollar terms, the reality is that nearly all of the risk arises from the 60% allocation to equities. Additionally, when a portfolio is equal-risk weighted as opposed to equal weighted, it may lead to superior risk-adjusted returns.

In the first part of this paper, we cover the economic rationale for implementing a risk parity approach in a multi-asset portfolio construction. In the second part of the paper, we give an overview of the S&P Risk Parity Indices.

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ETF Transactions by U.S. Insurers in Q2 2020

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Raghu Ramachandran

Head of Insurance Asset Channel

INTRODUCTION

In May 2020, we published our annual study of ETF usage by U.S. insurance companies. The data for that analysis is only available annually. However, because of the recent market volatility, we wanted to analyze the use of ETFs by U.S. insurance companies prior to the next annual analysis. While holdings data is not available on a quarterly basis, we were able to analyze ETF transactions. In this analysis, we compare how ETF trading varied between the more volatile first quarter and the calmer second quarter.

ETF TRADES

In the first quarter of 2020, U.S. insurance companies traded USD 24.6 billion in ETFs. In the second quarter, that volume slowed down, but companies still traded USD 13.9 billion in ETFs. Combined, insurance companies traded USD 38.4 billion in the first half of 2020. At the end of 2019, insurance companies only held USD 31.2 billion in ETF assets.

Companies traded heavily during the latter part of the first quarter during the period of increased volatility related to COVID 19. Trading volume dropped considerably during the beginning of the second quarter, until a spike in late May and early June (see Exhibit 1).

Exhibit 1

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