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Shooting the Messenger

Analyzing High Dividend Yield Strategies in Korea

Income in Indexing: How the iBoxx Liquidity Ecosystem Lends Well to Credit Markets – Part 2

Income in Indexing: How the iBoxx Liquidity Ecosystem Impacts Credit Markets – Part 1

Defense Beyond Bonds: Defensive Strategy Indices

Shooting the Messenger

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Anu R. Ganti

Senior Director, Index Investment Strategy

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Craig Lazzara

Managing Director, Core Product Management

Executive Summary

Index funds, which hardly existed 50 years ago, now play a prominent role in global financial markets.  Exhibit 1 illustrates the growth of assets tracking the S&P 500®, the most prominent index in the world’s largest equity market, but this trend has not been limited to the U.S. (nor to equities).

The growth of indexing has been driven by the inability of active managers, in aggregate, to outperform passive benchmarks.  This is not a new development—it was first reported 90 years ago.  The rise of passive management is the consequence of active performance shortfalls.

These shortfalls can be attributed to three factors:

  • The professionalization of investment management;
  • Cost; and
  • The skewness of stock returns.

Since each of these factors is likely to persist, the advantage of indexing over active management is likely to persist as well.

Some Important Observations

Until the early 1970s, there were no index funds; all assets were managed actively.  The subsequent shift of assets from active to passive management, as illustrated in Exhibit 1, surely must count as one of the most important developments in modern financial history.  Our intent in this paper is to suggest why this transformation came about; the answer, in our view, lies both in a set of observations and in the subsequent explanation of those observations.

The observations to which we refer are designed to document the degree to which active managers are able to add value to the performance of passive benchmarks.  The earliest study of active management of which we’re aware dates to 1932.  Alfred Cowles examined the stock selection records of both financial services and fire insurance companies (what we would today call property and casualty insurers).  Both sets of forecasters underperformed the average common stock during the period Cowles examined.  The same was true of a number of financial publications that made predictions of the overall level of the stock market.  For all these cases, “statistical tests…failed to demonstrate that they exhibited skill, and indicated that they more probably were [the] results of chance.”

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Analyzing High Dividend Yield Strategies in Korea

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Jason Ye

Director, Strategy Indices

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Izzy Wang

Analyst, Strategy Indices

Introduction

Dividend indices are one of the most widely recognized factor-based strategies. According to Morningstar, as of Dec. 31, 2021, the number of dividend-focused exchange-traded products (ETPs) globally has reached 344, with over USD 385 billion in AUMs. In 2021, dividend ETPs drew close to USD 50 billion of assets inflow. In Korea, the dividend factor is the most popular factor, with over USD 642 million in AUMs, which accounted for 47% of the Korean factor ETP market.

In this paper, we will take a deep dive into the Korean dividend market and analyze how the Korean high dividend yield strategy has performed historically.

Korea Dividend Market

Unlike investors in the U.S., Korean investors face higher uncertainties when it comes to dividend payment. This is because, in Korea, the dividend ex-date is fixed to be the penultimate business day of the fiscal year-end and comes before the dividend announcement date.

Historically, Korean companies have been reluctant to pay out a dividend, preferring to keep the profit and reinvest. However, the Korean government has implemented a series of activities intended to induce companies to pay out more dividends over the past decade, which could encourage broader equity ownership, improve corporate governance and enhance shareholders’ rights. Therefore, throughout the past decade, the government has made various attempts to cultivate a dividend payment culture.

To guide institutional investors in effectively exercising their stewardship responsibilities, the Financial Services Commission (FSC) first introduced the Stewardship Code in 2015. In 2018, the nation’s largest institutional investor National Pension Service (NPS) took the lead in adopting the Stewardship Code, followed by other institutions. As of Aug. 31, 2022, 193 institutional investors participated in the Stewardship Code. As major stakeholders of Korean equities, these institutions could effectively influence companies to improve dividend policy and increase profit distribution.

Meanwhile, the government continued to provide a tax incentive to encourage payouts. During 2015-2017, the government lowered dividend tax from 14% to 9% for stockholders of qualified high-dividend companies. In 2022, the government proposed a 3% corporate tax cut to boost corporate income, which could end up benefiting dividend payouts. After years of efforts, a significant shift in the attitude toward dividends is beginning.

We have observed three major trends in the Korean dividend market over the past decade.

  1. Steady growth of dividend pool.
  2. Improved dividend sustainability.
  3. Increased adoption of interim dividend.
Steady Growth of Dividend Pool

Over the past 10 years, the Korean market has shown improvement in various aspects, indicating a shift toward a dividend payment culture. The size of the total dividend pool for companies in the S&P Korea BMI reached USD 43 billion in 2021, which is more than three times that in 2011 (see Exhibit 1). Its 10-year compound annual growth rate (CAGR) reached 12.4%—the highest among developed markets in the Asia Pacific region and greater than the global average of 6.9% (see Exhibit 2).

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Income in Indexing: How the iBoxx Liquidity Ecosystem Lends Well to Credit Markets – Part 2

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Frans Scheepers, CFA

Global Head of Fixed Income Products

S&P Dow Jones Indices

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Nicholas Godec

Head of Fixed Income Tradables

S&P Dow Jones Indices

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Brian D. Luke

Senior Director, Head of Fixed Income Indices - Americas

Part 2: Derivatives and Lending Markets

The iBoxx USD Liquid High Yield Index has served as the leading benchmark for the high yield market since its debut in 2006. Designed to track the most liquid instruments in the high yield market, the index supports a broad trading ecosystem via ETFs and derivatives. In Part 1, “Income in Indexing: How the iBoxx Liquidity Ecosystem Impacts Credit Markets,” we highlighted the growth of the high yield bond market and the index construction attributes that contribute to the iBoxx USD Liquid High Yield Index liquidity ecosystem. We measured the effectiveness of the index methodology in current markets through bond liquidity analysis. In Part 2 of this paper, we continue to analyze liquidity in different forms by exploring the fund, derivative and securities lending markets that propagate liquidity in various forms.

The iBoxx Liquidity Ecosystem

The iBoxx indices act as a central hub to a diverse and active tradable ecosystem, spanning active funds, ETFs, total return swaps and futures. Other instrument types, such as credit default swap indices, are complemented by the iBoxx ecosystem, which has also expanded to include ETF options, securities lending and portfolio trading as derivatives tracking the index have become more liquid.

Income in Indexing: How the iBoxx Liquidity Ecosystem Impacts Credit Markets – Part 2 - Exhibit 1

ETFs have been used to access high yield markets since the first ETF tracking the iBoxx USD Liquid High Yield Index launched in 2007. Beyond ETFs, total return swaps on the iBoxx USD Liquid High Yield Index are often used to express short positions, or to hedge a long position. In 2021, iBoxx Standardized Total Return Swaps and futures volumes linked to the iBoxx USD Liquid High Yield Index were USD 57.3 billion and USD 40.6 billion, respectively. Given the USD 21.4 billion in ETF AUM tracking the iBoxx USD Liquid High Yield Index at year-end 2021, derivative trading volume (iBoxx TRS and iBoxx Futures)-to-ETF AUM was 4.6x. Lastly, holders of funds tracking the iBoxx USD Liquid High Yield Index are seeing increased demand for their shares in the securities lending market.

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Income in Indexing: How the iBoxx Liquidity Ecosystem Impacts Credit Markets – Part 1

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Frans Scheepers, CFA

Global Head of Fixed Income Products

S&P Dow Jones Indices

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Nicholas Godec

Head of Fixed Income Tradables

S&P Dow Jones Indices

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Brian D. Luke

Senior Director, Head of Fixed Income Indices - Americas

Part 1: Index and Pricing

The iBoxx USD Liquid High Yield Index has served as the leading benchmark for the high yield market since its debut in 2006. Designed to track the most liquid instruments in the high yield market, the index supports a broad trading ecosystem via ETFs and derivatives. Though they have been generally excluded from traditional aggregate-type fixed income benchmarks in the past, high yield bonds remain a growing asset class that has historically offered yields that exceed investment grade debt (see Exhibit 1). In exchange for incremental yield are typically heightened credit and liquidity risk. In this article, we examine the components of the iBoxx USD Liquid High Yield Index (“IBOXHY”) that have demonstrated potential mitigation of liquidity risk. Contrasting other broad benchmarks to IBOXHY helps explain why liquid index construction matters, not just for the indices, but for the broader corporate bond ecosystem. We estimate the size of the ecosystem currently supported by IBOXHY to be in the hundreds of billions of U.S. dollars, and liquidity is measured as its underlying bond bid offer spreads. Because of the index design, it has been able to achieve the liquidity objective for over 15 years.

Promoting transparency with an emphasis on liquidity, the indices are constructed to serve as a basis for tradable instruments like ETFs, swaps and futures. In a follow up to this paper, we will explore the fund, derivative and securities lending markets that propagate liquidity in various forms.

Income in Indexing: How the iBoxx Liquidity Ecosystem Impacts Credit Markets – Part 1 - Exhibit 1

The iBoxx Liquidity Ecosystem in Different Markets

ETFs have been used to access high yield markets since the first ETF tracking the iBoxx USD Liquid High Yield Index launched in 2007. We will detail how index construction plays a pivotal role in identifying the optimal mix of bonds to track the performance of the overall high yield market. Beyond ETFs, total return swaps on IBOXHY are often used to express short positions, or to hedge a long position. We will discuss how volumes in that market have exceeded assets in the funds several times over, perhaps due to use as a means to hedge risk. For example, in 2021 iBoxx Standardized Total Return Swaps and futures volumes linked to the iBoxx USD Liquid High Yield Index were USD 57.3 billion and USD 40.6 billion, respectively. Given the USD 21.4 billion in ETF AUM tracking the iBoxx USD Liquid High Yield Index at year-end 2021, derivative trading volume-to-ETF AUM was 4.6x. Lastly, holders of funds tracking the iBoxx USD Liquid High Yield Index are seeing increased demand for their shares in the securities lending market, highlighting the growing opportunity set that has evolved around the iBoxx HY ecosystem. Thus, by comparing liquidity of eligible and ineligible bonds in the securities lending market of the iBoxx USD Liquid High Yield Index, we see new ways to independently measure liquidity. Each of these areas shines a light on how together they contribute to the index liquidity ecosystem.

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Defense Beyond Bonds: Defensive Strategy Indices

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Fei Mei Chan

Director, Core Product Management

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Craig Lazzara

Managing Director, Core Product Management

EXECUTIVE SUMMARY

  • The S&P 500® peaked on Jan. 3, 2022, and recorded a 20% decline in the first six months of the year. Bonds declined at the same time, as the U.S. 10-Year Treasury yield more than doubled.

  • The combination of falling stock prices and rising interest rates is historically uncommon. When the equity and bond markets decline simultaneously, defensive equity factors—which aim to provide protection during falling markets and participation in rising markets—become more relevant.

  • We explore ways of utilizing defensive strategy indices in order to improve the risk/return profile of a traditional asset allocation.

    Defense Beyond 
Bonds: Defensive Strategy Indices - Exhibit 1

    Rising Rates and Falling Stocks

    The S&P 500 reached its most recent peak on Jan. 3, 2022, and declined 20% through June 30, 2022. Were investors prescient, of course, avoiding losses would be easy: simply shift from equities to cash on or about Jan. 3, 2022. For those of us not gifted with omniscience, however, market timing is an inadequate solution.

    As Exhibit 1 suggests, in the first six months of 2022, investors were beset not only by the declining stock market, but also by rising interest rates. (The S&P U.S. Treasury Bond 7-10 Year Index was off by -10.6% as rates more than doubled.) This represents a radical change of fortune from the rising stock and bond markets that characterized most of the past 40 years. It also has an important implication for portfolio construction. Historically, investors who were unwilling or unable to bear the full risk of the equity market could hedge by constructing a balanced portfolio of stocks and bonds. During the bull market in bonds that began in 1981, such defensive allocations did not require a major sacrifice in returns. If the bull market in bonds has ended, however, defensively minded investors might seek other ways of limiting their equity risk.

    Exhibit 2 shows that some factor indices would have dampened the S&P 500’s volatility in the first half of 2022; some even outperformed the bond market. Our intent in this paper is to explore what we can learn from the history of these indices. Which factors are best suited to providing defensive outcomes?

    Defense Beyond Bonds: Defensive Strategy Indices - Exhibit 2

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