In This List

Examining Share Repurchasing and the S&P Buyback Indices

The Active Manager's Conundrum

The Half-Discovered Continent: U.S. Equities beyond the S&P 500®

Fleeting Alpha: The Challenge of Consistent Outperformance

The Valuation of Low Volatility

Examining Share Repurchasing and the S&P Buyback Indices

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Priscilla Luk

Managing Director, Global Research & Design, APAC

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Liyu Zeng

Director, Global Research & Design

Since 1997, share repurchases have surpassed cash dividends and become the dominant form of corporate payout in the U.S.  This paper gives an overview of share repurchases in U.S., including trends in corporate payouts, major types of and motives behind share repurchases, and the price impact.  In the following sections, the performance and attributes of the S&P 500® Buyback Index is discussed, and the study is extended to the mid- and small-cap spaces in the U.S.

EXECUTIVE FINDINGS

  • Over a long-term investment horizon, buyback portfolios generated positive excess returns over their benchmark indices in the large-, mid-, and small-cap segments of the U.S. market.
  • All buyback portfolios generated higher average monthly excess returns over their benchmark indices in down markets than in up markets, regardless of weighting methods.
  • Compared with dividend portfolios, buyback portfolios tended to have lower dividend yields and most of their outperformance was driven by capital gains rather than dividend income. Buyback portfolios achieved more balanced win ratios and excess returns in both up and down markets, which is a good complement to defensive portfolios that focus on strategies such as dividends and low volatility.
  • The equal-weighting method employed in the construction of our buyback indices enhances win ratios and excess returns in up markets, making the outperformance of buyback indices more balanced in both up and down markets. The impact of equal weighting is more significant in the large-cap space than in the mid- and small-cap spaces.
  • Both equal-weighted and market-cap-weighted buyback portfolios were tilted toward high earning yield in the past 20 years that ended Dec. 31, 2019.  The overlay of equal weighting gives the portfolios an extra small-cap bias, especially in the large-cap space.

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The Active Manager's Conundrum

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Fei Mei Chan

Director, Index Investment Strategy

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Anu R. Ganti

Senior Director, Index Investment Strategy

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Tim Edwards

Managing Director, Index Investment Strategy

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Craig Lazzara

Managing Director, Global Head of Index Investment Strategy

EXECUTIVE SUMMARY

  • Below-average market volatility is typically associated with above-average returns. Given a choice, therefore, most investors would prefer low volatility to high.
  • For active managers, however, the choice is less obvious: lower market volatility is associated with lower correlation and lower dispersion, both of which make active management harder to justify.
  • Active portfolios are typically more volatile than their benchmarks; how much more volatile depends in part on correlations. Active managers pay an implicit cost of concentration, which rises when correlations decline.
  • Low dispersion makes it harder for active managers to add value, and reduces the incremental return of those who do.
  • These perspectives highlight the conflict between the goals of absolute and relative return generation.

A SIMPLE QUESTION

Should an active manager prefer to operate in a low volatility environment or a high volatility environment? What factors should influence this decision?

At first glance, the choice seems fairly easy. Exhibit 1 reminds us that volatility and returns are inversely related. Rising volatility typically penalizes results and vice versa.

We can see this more directly in Exhibit 2. Here, we separated the months in our database by intra-month volatility and examined return data in each set of months.

These exhibits make the manager’s choice look obvious: if volatility is high, returns tend to be negative; if volatility is low, average returns are substantially positive. Positive returns mean that the manager’s clients are making money, which they usually appreciate, and that the manager’s fees (if asset-based) are also rising. Attracting new assets is easier in a rising market, whereas “investors do not reward outperformance in down markets with higher subsequent flows.”

Lower volatility means that managers and clients alike enjoy a smoother return path with fewer surprises. The manager should obviously wish for low volatility, both for its own sake and because of its connection to higher returns. What could go wrong?

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The Half-Discovered Continent: U.S. Equities beyond the S&P 500®

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Chris Bennett

Director, Index Investment Strategy

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Tim Edwards

Managing Director, Index Investment Strategy

EXECUTIVE SUMMARY

• Mid- and small-cap U.S. equities represent a significant piece of the global market, but they are overlooked by many international investors, particularly in Europe.

• Historically, the S&P MidCap 400® and S&P SmallCap 600® have outperformed many global equity markets.  However, the performance of many active funds investing in mid- and small-cap U.S. equities has been disappointing.

• With index-linked vehicles such as exchange-traded funds (ETFs) arising in recent years to offer low-cost, passive exposures to mid and small caps, global investors may find it timely to consider a passive allocation.

• We examine the benefits of exploring the U.S. equities market beyond large caps from a European investor’s perspective and with a focus on S&P Dow Jones Indices’ S&P MidCap 400 and S&P SmallCap 600.

 

INTRODUCTION

Investors the world over have made allocations to U.S. stocks, which include some of the world’s largest companies.  Ex-U.S. investors appear to have explored little beyond the so-called “blue chips,” however. 

As shown later, European fund investors, in particular, have minimal exposure to small or mid-sized U.S. equities.  This lack of interest is puzzling, not least as they represent significant market segments in absolute terms; the S&P MidCap 400 alone has a market capitalization similar to the entire French stock market, while, in combination, the S&P MidCap 400 and S&P SmallCap 600 are roughly the same size as the UK’s stock market.

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Fleeting Alpha: The Challenge of Consistent Outperformance

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Berlinda Liu

Director, Global Research & Design

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Andrew Cairns

Associate Director, Global Research & Design

INTRODUCTION

The phrase “past performance is no guarantee of future results” (or some variation thereof) can be found in most funds’ literature, and for good reason: a wealth of studies show a lack of long-term performance persistence among actively managed mutual funds. However, many investors appear to believe that winners persist: past performance and related metrics remain important factors in manager selection.

Since 2002, S&P Dow Jones Indices has published the SPIVA® U.S. Scorecard, measuring the percentage of active managers that beat their benchmarks across various equity and fixed income categories. Its sister report, the Persistence Scorecard, shows the likelihood that a top-quartile manager maintains its status in subsequent periods.

By marrying the two reports, this paper studies the degree to which outperforming funds from one period continue to beat their benchmarks thereafter. Specifically, we first identify funds that beat their benchmarks, based on three-year annualized returns, net-of-fees. We then examine whether these funds (the “winners”) can continue to outperform during each of the next three one-year periods.

Our results show that among equity funds that beat their benchmarks over the three-year period ending Sept. 30, 2016, the performance persistence among domestic and international equity categories in the following three years was worse (in general) than a random draw. In other words, past performance did not typically help identify superior performing managers in advance.


DATA AND METHODOLOGY

The University of Chicago’s Center for Research and Security Prices (CRSP) Survivorship-Bias-Free US Mutual Fund Database serves as the underlying data source for our study. The universe used for the study only includes actively managed domestic U.S. equity funds. Index funds, sector funds, and index-based dynamic (leveraged or inverse) funds are excluded from the sample. To avoid double counting multiple share classes, only the share class with greater assets is used. At each measurement period, the universe consists of over 2,300 active equity funds, on average (see Appendix I).

Based on the earliest availability of Lipper style classifications, our study covers the period from March 31, 2000, through Sept. 30, 2019. On a quarterly basis beginning on March 31, 2003, we compute the trailing threeyear annualized returns for each fund in our universe, as well as for their benchmarks. We then identify funds that beat their benchmarks and track their relative performance in each of the next three years. By identifying funds that beat their benchmarks as winners and those that do not as losers, this approach applies the “winner-winner, winner-loser” methodology developed by Brown and Goetzmann (1995) and examines if winners in period t are also winners in t + j, where j = Year 1, Year 2, and Year 3.

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The Valuation of Low Volatility

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Fei Mei Chan

Director, Index Investment Strategy

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Craig Lazzara

Managing Director, Global Head of Index Investment Strategy

EXECUTIVE SUMMARY

• Low volatility strategies, as the name suggests, typically perform well when markets decline. Challenging traditional capital asset pricing theory, they have, anomalously, outperformed their benchmarks over time despite exhibiting lower risk.

• Due to their popularity in recent years, some critics have claimed that low volatility stocks are overbought and overvalued.

• We attempt to quantify the current valuation of low volatility. Moreover, we ask if it is possible to identify valuation environments during which low volatility strategies offer more bang for the buck.

• Relative valuation for the S&P 500® Low Volatility Index has gradually become more expensive since 2000; at the end of 2019, the low volatility index was modestly cheaper than its parent S&P 500. However, as a leading indicator of the relative performance of low volatility strategies, value has never been particularly valuable.

THE RISE OF LOW VOLATILITY

What is commonly referred to as the low volatility anomaly is not a recent discovery; it has been well documented in academic research for over four decades.1 Popularized in the turmoil following the 2008 financial crisis, low volatility strategies, as the name suggests, have served well in times of market distress. The anomalous aspect is that despite their lower risk, low volatility strategies have outperformed their benchmarks over time, challenging classic capital asset pricing theory that risk and reward go hand in hand. The long-term outperformance of low-risk portfolios is perhaps “the greatest anomaly in finance.”2

The S&P 500 Low Volatility Index3 is one example of such a strategy. From January 1991 to December 2019, this index delivered an average annual return of 11.28%, compared with 10.44% for the S&P 500, with less volatility (standard deviations of 11% and 14%, respectively). This same risk/return profile is consistent with history extending to the 1970s.4

In recent years, low volatility strategies have gained fortune along with fame, gathering about $130 billion in assets in more than 200 funds globally.5 Along with the generous inflows, concerns have risen around the valuation of the portfolios tracking low volatility strategies.6

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