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From Grass to Mass: An Index-Based Approach to Measuring Greenium in Green Bonds

Low Volatility and High Beta: A Study in Backtest Integrity

Harnessing Multi-Factor Strategies Close to the Core

S&P 500 Dividend Aristocrats: The Importance of Stable Dividend Income

Returns, Values, and Outcomes: A Counterfactual History

From Grass to Mass: An Index-Based Approach to Measuring Greenium in Green Bonds

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Brian D. Luke

Senior Director, Head of Commodities and Real Assets

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Catalina Zota

Associate Director, Fixed Income Product Management

EXECUTIVE SUMMARY

  • Green bonds have historically exhibited a green premium—or "greenium"—meaning they have lower yields compared to non-green bonds with otherwise similar characteristics.
  • Rapid growth and increasing differentiation within the green bond market has led to better ways to measure greenium across global bond markets.
  • An index-based approach illustrates the level of greenium across bond markets; comparing current levels to historical ones suggests shrinking greenium in many major markets.

INTRODUCTION

Green bonds are tied to specific environmentally friendly projects of an issuer. The borrower agrees that the use of proceeds will be invested in environmentally friendly projects such as alternative clean energy, low carbon assets (e.g., green buildings, factories, or vehicles), or sustainable usage of water, pollution, or natural resources. In exchange for this commitment, the issuer seeks economic benefit in the form of a lower borrowing cost. First tapped by supranational borrowers such as the European Investment Bank and the World Bank, the index market value of green bonds surpassed USD 1 trillion in September 2021, expanding from sovereign and quasi-sovereign bonds to corporate and securitized debt.

The green bond market, as measured by the S&P Green Bond Index, has grown since its 2007 debut: growth in the market value of green bonds averaged 70% annually over the past decade, compared with 3% for the global bond market (see Exhibit 1). Along with surging growth, investor demand for green bonds has remained strong.

From Grass to Mass: An Index-Based Approach to Measuring Greenium in Green Bonds: Exhibit 1

S&P Global Ratings' research on the European credit market observed initial sustainable bond yields to be lower compared with conventional bonds, incentivizing issuers. Despite a lower yield, or greenium, investors absorbed the liquidity of green bonds, further stimulating supply. In cases of no greenium at issuance, the research highlighted economic incentives for the investor in the form of outperformance. Tracking historical performance of two nearly identical German government bunds demonstrated additional spread tightening of 5 bps of the bund that was classified as green in the year since issuance.

Historical pricing appeared to demonstrate a price premium for green over non-green, or vanilla, bonds, as green debt represents just 2% of the overall market. More recent evidence suggests mutual benefits for investors and issuers alike as green and vanilla bond yields converge over time. This paper analyzes factors contributing to the changing relative valuation between green and vanilla bonds. Markets covered include European government agency and corporate bonds, as well as U.S. corporate and municipal markets.

Many issuers have repeatedly tapped the green bond market, allowing for issuer-based credit curves. In select cases, they provide good comparisons, but this is rare. Often, new green bonds cannibalize matured vanilla bonds, creating new issue bias. Applying a comprehensive credit valuation approach, this paper analyzes green and vanilla bonds by issuer, sector, and credit rating.

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Low Volatility and High Beta: A Study in Backtest Integrity

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Craig Lazzara

Managing Director, Index Investment Strategy

EXECUTIVE SUMMARY

  • In April 2011, S&P Dow Jones Indices launched the S&P 500® Low Volatility Index (Low Volatility) and the S&P 500 High Beta Index (High Beta). Their recent 10th “birthday” allows us to compare the backtested performance with which they were introduced with actual live performance.
  • Low volatility and high beta strategies are designed to access specific patterns of returns relative to the market. Low volatility should attenuate the market’s returns (in both directions), while high beta should amplify them.
  • The actual performance of both Low Volatility and High Beta has been consistent with these expectations.

Low Volatility and High Beta: A Study in Backtest Integrity: Exhibit 1

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Harnessing Multi-Factor Strategies Close to the Core

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Rupert Watts

Senior Director, Strategy Indices

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Andrew Innes

Head of EMEA, Global Research & Design

EXECUTIVE SUMMARY

Factors that outperform over time are also prone to extended periods of underperformance, which are difficult to time. For investors seeking exposure to factor risk premia but with greater diversification and reduced cyclicality, multi-factor strategies may be more suitable than single factors.

Accordingly, S&P DJI presents a new series of multi-factor indices, collectively known as the S&P QVM Top 90% Indices, covering the U.S. large-cap, mid-cap, and small-cap universes (S&P 500®, S&P MidCap 400®, and S&P SmallCap 600®, respectively). In this paper, we analyze the indices' methodology and performance characteristics. Multi-factor scores are based on the average of three separate factors: quality, value, and momentum (QVM). This new index series encompasses a high proportion of the universe, whereas existing multi-factor indices are typically more concentrated.

Different multi-factor strategies produce different outcomes and positioning. Construction matters. These new indices select constituents in the top 90% of the universe, ranked by their multi-factor score and weighted by float-adjusted market capitalization (subject to constraints).

The indices generated moderate outperformance by removing the lowest-ranked decile of stocks. This plus float-adjusted market cap weighting allows the indices to retain many of the core features of the benchmark. In summary, the key historical performance characteristics of the S&P QVM Top 90% Indices include:

  • Moderate outperformance versus the benchmark;
  • Low tracking error;
  • Low turnover;
  • Low active share; and
  • Sector weights consistent with the benchmark.

INTRODUCTION

With the rising adoption of factor indices, the traditional boundaries between passive and active investing have become increasingly blurred. For decades, institutional investors constructed portfolios from a combination of market-cap-weighted index funds and active funds. Now, factor-based investing straddles these two approaches and enables institutional and retail investors alike to implement active strategies through passive vehicles.

Single-factor equity strategies (quality, value, or momentum) have been widely adopted to harvest each factor risk premium that could reward market participants over the long term. However, each factor is susceptible to periods of underperformance dependent on the market environment and economic cycle. This induces some market participants to attempt the notoriously difficult task of timing factors through tactical allocation strategies.

Harnessing Multi-Factor Strategies Close to the Core: Exhibit 1

An alternative solution is to employ a transparent multi-factor strategy that aims to capture exposures across all targeted factors simultaneously. Such a strategy exploits the potential diversification benefits by combining factor returns that have relatively low correlation to one another (see Exhibit 2). Subsequently, the diversified factor exposures may provide more stable excess returns over shorter time horizons, while still capturing their average long-term risk premia. Importantly, this approach avoids the need to subjectively time factor exposures.

Harnessing Multi-Factor Strategies Close to the Core: Exhibit 2

Exhibit 3 demonstrates the key differences between single-factor strategies and the multi-factor strategy in these indices. Here the full-year return of three single factor indices (S&P Quality, S&P Enhanced Value, and S&P Momentum), the S&P QVM Top 90% Multi-factor Index, and their respective benchmarks are ranked each year. Across all three universes (S&P 500, S&P MidCap 400, and S&P SmallCap 600), the wide variability in the calendar year performance rank of each single-factor strategy is evident. Conversely, the multi-factor strategy more consistently exhibits stable excess returns (higher performance rank) across most calendar years with respect to its benchmark.

Harnessing Multi-Factor Strategies Close to the Core: Exhibit 3

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S&P 500 Dividend Aristocrats: The Importance of Stable Dividend Income

EXECUTIVE SUMMARY

  • Dividends play an important role in generating equity total return. Since 1926, dividends have contributed approximately 32% of total return for the S&P 500, while capital appreciations have contributed 68%.  Therefore, sustainable dividend income and capital appreciation potential are important factors for total return expectations.
  • Companies use stable and increasing dividends as a signal of confidence in their firm’s prospects, while market participants consider such track records as a sign of corporate maturity and balance sheet strength.
  • The S&P 500 Dividend Aristocrats is designed to measure the performance of S&P 500 constituents that have followed a policy of increasing dividends every year for at least 25 consecutive years.
  • The S&P 500 Dividend Aristocrats exhibits both capital growth and dividend income characteristics, as opposed to alternative income strategies that may be pure yield or pure capital-appreciation oriented.
  • Across all of the time horizons measured, the S&P 500 Dividend Aristocrats exhibited higher returns with lower volatility compared with the S&P 500, resulting in higher Sharpe ratios.
  • As of 2021, S&P 500 Dividend Aristocrats constituents included 65 securities, diversified across 11 sectors (see Exhibit 13 in the Appendix).
    • The constituents have both growth and value characteristics.
  • The composition of the S&P 500 Dividend Aristocrats contrasts with that of traditional dividend-oriented benchmarks that have a steep value bias and have high exposure to the Financials and Utilities sectors. At each rebalancing, a 30% sector cap is imposed to ensure sector diversification.
  • The S&P 500 Dividend Aristocrats follows an equal weight methodology.
    • This treats each company as a distinct entity, regardless of market capitalization.
    • This also eliminates single stock concentration risk.

INTRODUCTION

Dividends have interested market participants and theorists since the origins of modern financial theory.  As such, many researchers have investigated the various topics related to dividends and dividend-paying firms.  Previous studies by S&P Dow Jones Indices have shown that over a long-term investment horizon, dividend-paying constituents of the S&P 500 have outperformed the non-payers of dividends and the overall broad market on a risk-adjusted basis.

In recent years, the increasing amount of academic and practitioner research demonstrates that dividend yield is a compensated risk factor and has historically earned excess returns over a market-cap-weighted benchmark.  When combined with other factors such as volatility, quality, momentum, value, and size, dividend yield strategies can potentially offer exposure to systematic sources of return.

In this paper, we show that dividend yield is an important component of total return.  We also highlight pertinent characteristics of the S&P 500 Dividend Aristocrats, an index that seeks to measure the performance of the S&P 500 constituents that have increased their dividend payouts for 25 consecutive years.  We show that the S&P 500 Dividend Aristocrats possesses desirable risk/return characteristics, offering higher risk-adjusted returns and downside protection than the broad-based benchmark.  In addition, our analysis shows that the S&P 500 Dividend Aristocrats is sector diversified and displays growth and value characteristics.

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Returns, Values, and Outcomes: A Counterfactual History

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Craig Lazzara

Managing Director, Index Investment Strategy

EXECUTIVE SUMMARY

  • Any analysis of investment policy or strategy must be based on historical data. Even if an analyst wants to extrapolate into the future (which we do not), extrapolations must start with the past.
  • But the historical data that we observe were not inevitable; history might have turned out differently than it actually did.
  • In this paper, we construct a counterfactual history of the last 40 years of U.S. equity returns, and explore what those histories could imply for investment policy.
  • Although the range of possible outcomes is quite wide, one consistent conclusion is that long-term investors in large-capitalization U.S. equities would have been advantaged by choosing passive rather than active management.

Returns, Values, and Outcomes: A Counterfactual History: Exhibit 1

INTRODUCTION

We often write about equity markets and the potential implications of various investment strategy choices.  What are the implications of the choice between active and passive management? How have factor or “smart beta” strategies performed in various economic environments? What do market dynamics tell us about the investment opportunity set?

All of these questions, and others like them, are important, but all are questions about returns.  Investors, however, live not with a series of returns, but rather with portfolio values.  In this paper, we model the connection between returns and portfolio values over a long-term historical horizon.

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