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Evaluating Passive Value Strategies

Sector Effects During Elections

Conviction, Confidence, and Courage

A Case for Dividend Growth Strategies

Fleeting Alpha Scorecard: The Challenge of Consistent Outperformance Year-End 2019

Evaluating Passive Value Strategies

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Jason Ye

Associate Director, Strategy Indices

EXECUTIVE SUMMARY

  • S&P Dow Jones Indices produces three families of value indices—the S&P Value Indices, the S&P Pure Value Indices, and the S&P Enhanced Value Indices. These families were developed with specific objectives in mind and have nuances of which market participants should be aware.  In this paper, we use the S&P 500® Value, the S&P 500 Pure Value, and the S&P 500 Enhanced Value Index to illustrate the differences.
  • The S&P 500 Value is a broad market, capitalization-weighted index with a large investment capacity for products tracking the index. This makes it a relevant benchmark for performance evaluation, as well as making it suitable for those seeking a traditional “buy-and-hold” index-linked investment implementation with a tilt toward value style.  By design, this index has lower value exposure than the S&P 500 Pure Value and the S&P 500 Enhanced Value Index, as well as a lower tracking error against the S&P 500. 
  • The S&P 500 Pure Value is a high conviction value index. It aims for a higher exposure to the value style than the S&P 500 Value. Its style score weighting tilts aggressively toward value securities, but may limit the investment capacity of the products tracking this index relative to those tracking the S&P 500 Value and the S&P 500 Enhanced Value Index.
  • The S&P 500 Enhanced Value Index balances the tradeoff between value exposure and the capacity of products tracking the index.  Its modified cap weighting targets the value factor while maintaining weights tied to market capitalization.

INTRODUCTION

Value investing is a well-known strategy that seeks to exploit perceived differences between a security’s price and an assessment of its true underlying worth.  As intuitive and straightforward as the strategy sounds, there are several nuances to consider when constructing a value portfolio.  At S&P Dow Jones Indices, we offer several value indices for investors with different purposes.  An investor should consider carefully which is the most appropriate value index to use.

The S&P 500 Value and the S&P 500 Pure Value are part of the S&P U.S. Style Indices.  The S&P 500 Enhanced Value Index is part of the S&P Factor Indices.  The style indices are derived from traditional style boxes and are broadly used to determine the investment style of a fund.  Factors are the underlying primary drivers of risk and return within a portfolio.  Decades of research have documented several factors that provide a premium, such as value, quality, and low volatility.  Factor indices are designed to capture those premiums.

The differences between the S&P 500 Value and the S&P 500 Pure Value have been well documented in research by S&P DJI. This paper aims to serve as a complement to the existing research, while focusing on identifying the differences between the S&P 500 Pure Value and the S&P 500 Enhanced Value Index.  We will look into the index construction differences among the S&P 500 Value, the S&P 500 Pure Value, and the S&P 500 Enhanced Value Index and then discuss how variations in index construction lead to differences in risk/return profiles, characteristics, and risk exposures.

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Sector Effects During Elections

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Craig Lazzara

Managing Director, Global Head of Index Investment Strategy

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Anu R. Ganti

Senior Director, Index Investment Strategy

“When we got into office, the thing that surprised me most was to find that things were just as bad as we'd been saying they were.”

- John F. Kennedy

EXECUTIVE SUMMARY

The value of stock selection skill rises when dispersion is high; a larger gap between winners and losers means that active equity managers have a better chance to display their selection abilities.1  This logic also applies to active managers operating at a higher level of aggregation, for example by expressing tactical market views through sector rotation. The importance of sectors tends to be greater than average during the Novembers when U.S. federal (and especially presidential) elections take place. Sector allocation decisions can add (or subtract) greater value in these months.  British and Canadian data are consistent with the U.S. results.

BACKGROUND

Dispersion, or the index-weighted standard deviation of returns, gives us a convenient way to measure the potential benefit of active decisions.2  Successful active managers—be they stock pickers, sector rotators, or factor investors—can add more value when dispersion is high than when it is low.3  Dispersion also provides a useful framework for understanding the importance of sectors in generating returns.

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Conviction, Confidence, and Courage

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Craig Lazzara

Managing Director, Global Head of Index Investment Strategy

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Anu R. Ganti

Senior Director, Index Investment Strategy

EXECUTIVE SUMMARY

Never wish to show courage, a wise man once counseled; courage can be displayed only in circumstances where one’s natural instinct is to be afraid, and fear is an unpleasant emotion.  This principle, with obvious qualifications, applies to investment management.  Successful portfolio management can require holding positions when one’s natural instinct is to sell.

ONCE UPON A TIME

It is Dec. 31, 1999.  You are a professional portfolio manager pondering long-term stock selections for your clients.  You share Warren Buffet’s view that “Our favorite holding period is forever,” and you decide to ask each of your four favorite Wall Street forecasters to recommend a stock to hold indefinitely.  They obligingly recommend four different names, denoted for now as Stocks A through D, which you carefully consider.

You’re well aware that some recommendations work out better than others.  What might cause you to lose confidence in any of these four stocks?  Since you will be buying the stocks in the expectation that they will go up, and in fact will outperform the market, a period of disappointing returns might weaken your determination to hold forever.

While contemplating all this, you have been holding a very old bottle of wine that a friend gave you for your last birthday.  You open the bottle, thinking that a taste might help resolve your perplexity.  As you remove the cork, suddenly vapor spews out and a genie emerges.  In gratitude for your having released him, he offers you a wish.

Of course, what you wish is to know which of the four stocks will be the best performer for the next 20 years.  Unfortunately, our genie has been corked up with the wine for a bit too long.  He knows a good bit about volatility but very little about the returns of individual stocks.  The genie does know that the market will go up in the next 20 years, and that individual stock returns will be highly skewed, as Exhibit 1 illustrates.  The median stock in the S&P 500® will appreciate by 52%, well below the average appreciation of 239%.  Only 267 of the 1,010 stocks that will appear in the S&P 500 for the next 20 years will beat the average.

Having been made aware that a relatively small number of stocks will determine your success or failure, you’re happy to have whatever specific information you can get, and ask the genie to tell you what he knows about the four recommendations.

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A Case for Dividend Growth Strategies

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Tianyin Cheng

Senior Director, Strategy Indices

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Izzy Wang

Analyst, Strategy Indices

Dividend strategies have gained a foothold with market participants seeking potential outperformance and attractive yields, especially in the low-rate environment since the 2008 financial crisis and the even lower-rate environment we’ve seen in 2020 as the world deals with the economic fallout from COVID-19.  

With the volatile economic situation that emerged in 2020, and market uncertainties putting pressure on corporate earnings, high-yielding companies without strong financial strength and discipline may not be able to sustain future payout and could be prone to dividend cuts and suspensions.

Stocks with a history of dividend growth, on the other hand, could present a compelling investment opportunity in an uncertain environment.  An allocation to companies that have sustainable and growing dividends may provide exposure to high-quality stocks and greater income over time, therefore buffering against market volatility and addressing the risk of rising rates to some extent.

This argument goes beyond the traditional realm of domestic large-cap stocks.  It also works for small- and mid-cap stocks and can be applied to international markets as well.

The S&P High Yield Dividend Aristocrats® is designed to track a basket of stocks from the S&P Composite 1500® that have consistently increased their dividends every year for at least 20 years.  This paper investigates the benefits of a dividend growth strategy by analyzing the characteristics of the S&P High Yield Dividend Aristocrats and comparing it to the S&P 500® High Dividend Index—a high-dividend strategy built on the S&P 500 (see the Appendix for an overview of the index’s methodology).  In addition, this paper illustrates a few indices that focus on the strongest dividend growers in global and international markets, including Canada, the eurozone, the U.K., Pan Asia, and Japan.

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Fleeting Alpha Scorecard: The Challenge of Consistent Outperformance Year-End 2019

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Berlinda Liu

Director, Global Research & Design

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Gaurav Sinha

Managing Director, Head of Americas Global Research & Design

SUMMARY

The Fleeting Alpha Scorecard is a semiannual report showing how well outperforming mutual funds from one three-year period continue to outperform thereafter. It combines two other S&P Dow Jones Indices reports, the SPIVA® U.S. Scorecard and the the Persistence Scorecard. The former measures the percentage of active managers that beat their benchmarks across various equity and fixed income categories. The latter shows the likelihood that strong performers in early periods maintain their status relative to other funds in subsequent periods.

For the Fleeting Alpha Scorecard, we first identify funds that beat their benchmarks, based on three-year annualized returns, net-of-fees. We then examine whether these funds continue to outperform during each of the next three one-year periods.

Report 1 shows the performance persistence of managers investing in various domestic and international equity categories, based on trailing three-year returns. Of the 18 categories in domestic equity, eight did not show funds with alpha persistence after three years. For example, as of Dec. 31, 2016, roughly 10% of 313 large-cap value funds had outperformed the S&P 500® Value in the previous three years. By the end of 2019, none of these 31 winners had maintained that status for three consecutive years. Of the winners at the end of 2016, just 12.9% of all domestic equity funds beat the S&P Composite 1500® in each of the three following one-year periods.

The vast majority of domestic equity funds showed little outperformance persistence, with notable exceptions in the small- and mid-cap spaces. Improvement in persistence mainly came from the mid-cap growth funds and the small-cap growth funds, in which 67% and 50%, respectively, of the past winners were able to generate positive alpha in the three subsequent one-year periods (in a small sample size).

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