IN THIS LIST

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

What Happened to the Index Effect? A Look at Three Decades of S&P 500 Adds and Drops

Returns, Values, and Outcomes: A Counterfactual History

Low Volatility and High Beta: A Study in Backtest Integrity

Contributor Image
Fei Mei Chan

Director, Index Investment Strategy

Contributor Image
Craig Lazzara

Managing Director, Core Product Management

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.

pdf-icon PD F Download Full Article

Harnessing Multi-Factor Strategies Close to the Core

Contributor Image
Andrew Innes

Head of EMEA, Global Research & Design

Contributor Image
Rupert Watts

Senior Director, Strategy Indices

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

pdf-icon PD F Download Full Article

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

Contributor Image
Aye Soe

Managing Director, Global Head of Core and Multi-Asset Product Management

Contributor Image
Smita Chirputkar

Director, Global Research & Design

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.

pdf-icon PD F Download Full Article

What Happened to the Index Effect? A Look at Three Decades of S&P 500 Adds and Drops

Contributor Image
Aye Soe

Managing Director, Global Head of Core and Multi-Asset Product Management

Contributor Image
Hamish Preston

Director, U.S. Equity Indices

EXECUTIVE SUMMARY

The index effect refers to the excess returns putatively associated with a security being added to, or removed from, a headline index.  Although it has been studied for decades, the index effect has received more attention in recent years amid the growth of passive investing and the accompanying speculation that stock returns may be affected by buying and selling pressures from index-tracking investors reacting to changes in index membership.

This paper analyzes S&P 500® additions and deletions from the start of 1995 to June 2021. We focus on the S&P 500 given it is the world’s most widely followed index—USD 13.5 trillion was indexed or benchmarked to the large-cap U.S. equity gauge at the end of 2020 —and so if the growth of passive investing contributed to an index effect, one might expect it to appear in S&P 500 additions and deletions.

Overall, our analysis corroborates the general consensus reflected in existing literature: the S&P 500 index effect seems to be in a structural decline (see Exhibit 1). Our analysis also suggests that an improvement in stock liquidity may help to explain the attenuation in the index effect over time.

pdf-icon PD F Download Full Article

Returns, Values, and Outcomes: A Counterfactual History

Contributor Image
Fei Mei Chan

Director, Index Investment Strategy

Contributor Image
Craig Lazzara

Managing Director, Core Product Management

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.

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.

pdf-icon PD F Download Full Article

Processing ...