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The Hidden Costs of Retail Purchases in Municipal Bonds

An Index Approach to Factor Investing in India

A Case for Dividend Growth Strategies

Approaches to Benchmarking Listed Infrastructure

ETFs in Insurance General Accounts – 2022

The Hidden Costs of Retail Purchases in Municipal Bonds

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Jason Giordano

Director, Fixed Income

Executive Summary

  • Despite recent innovations providing greater access to bond markets, the tax-exempt municipal bond investor base is still dominated by retail buyers.
  • Independent research on retail transactions has shown an average loss in income of 0.55%. In a low-rate environment, this number reflects a substantial potential disadvantage to retail bond buying.
  • These costs could potentially be avoided by accessing bonds through mutual funds or ETFs. ETFs have a distinct advantage in that shares of the fund can be exchanged without the need to incur any transactions in the institutional market.
  • In a low-yield environment, retail transaction costs can be a significant cause of erosion of potential returns.

Hidden Risks

Owning individual bonds has its risks and rewards.  However, buying a bond may also entail an unseen transaction cost that might not always be clear to purchasers.  This transaction cost exists because individual bonds are not typically sold with a commission.  Instead, a markup is built into the bond price.

This report offers a transparent look at these hidden transaction costs for U.S. municipal bonds.  To determine these costs, we used large, recently issued investment-grade bonds tracked by the S&P National AMT-Free Municipal Bond Index and the S&P AMT-Free Municipal Index Series, and high-yield municipal bonds tracked by the S&P Municipal Bond High Yield Index, in conjunction with bond transaction data provided by the Municipal Securities Rulemaking Board (MSRB).  This information can help market participants compare the cost of buying individual bonds to the cost of investing in bond alternatives, such as mutual funds and ETFs.

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An Index Approach to Factor Investing in India

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Jason Ye

Director, Strategy Indices

Introduction

Interest in factor investment solutions have significantly risen in the past decade.  In general, factor investing refers to an approach that targets stock characteristics that drive the difference in expected returns over the long term.  Sometimes, factor investing is referred to as smart beta, or strategic beta, because the factor approach will deviate the underlying portfolio from the market portfolio (the market beta) in a systematic method.  Some of the common factors that have been well documented in academic literature and adopted by the investment industry include low volatility, momentum, quality and value. Most of the evidence has been strong and promising that those factors can generate excess returns over the historical sample periods.  As of March 31, 2022, factor ETFs managed about USD 1.6 trillion assets globally, a 24.6% CAGR compared with the USD 178 billion 10 years ago.

How did these factors perform in the Indian market?  Can investors access factor performance through an indexing approach?  What are some applications of factor indices in the Indian market?  In this paper, we introduce the S&P BSE Factor Index Series, which implements the factor investing framework through an indexing approach to reflect the performance of the low volatility, momentum, quality and value factors.

In the following four sections, we provide brief descriptions of the S&P Dow Jones Indices (S&P DJI) approach to each of the common factors.  We will then provide an extensive discussion on the performance of the four factor indices, and a potential approach to combining the four factor indices to form an alternative for core equity allocation.

In each of the introductory sections, we follow the same framework to present the factors.  The underlying index universe to construct the S&P BSE Factor Index Series is the S&P BSE LargeMidCap, which is designed to represent the top 85% of the total market cap of the S&P BSE AllCap.  The S&P BSE LargeMidCap was launched in 2015, with the first value available in September 2005, so we use back-tested historical data starting on Sept. 30, 2005, to study the full sample period performance of each factor.  Every six months, at month-end in March and September, we sort the constituents of the S&P BSE LargeMidCap in order by each factor.  We then form equal-weighted quintiles and market-cap-weighted quintiles from those sorted values, denoting Quintile 1 as the stocks with the highest exposure to the factor and Quintile 5 as the stocks with the lowest exposure.  We are interested in whether Quintile 1 generates better performance than Quintile 5.  The performance of Quintile 1 tends to be more important, especially for long-only investors.  We analyze the performance from both the annualized compound return and the risk-adjusted return perspectives.

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A Case for Dividend Growth Strategies

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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 Global Financial Crisis and the even lower-rate environment we have seen since 2020, as the world deals with the economic fallout from COVID-19.  Entering 2022 with continuing global economic uncertainties, geopolitical disputes, high inflation and rising rates, a dividend growth strategy focusing on dividend sustainability and financial quality remains attractive.

With the volatile economic situation that has emerged since 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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Approaches to Benchmarking Listed Infrastructure

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Izzy Wang

Analyst, Strategy Indices

Investing in infrastructure has become popular among institutional and private investors in recent years.  Investors could be attracted to the potentially long-term, low-risk and inflation-linked profile that can come with infrastructure assets, and they may find that it is an alternative asset class that could provide new sources of return and diversification of risk.

Why Consider Investing in Infrastructure?

Infrastructure assets provide essential services that are necessary for populations and economies to function, prosper and grow.  They include a variety of assets divided into five general sectors: transportation (e.g., toll roads, airports, seaports and rail); energy (e.g., gas and electricity transmission, distribution and generation); water (e.g., pipelines and treatment plants); communications (e.g., broadcast, satellite and cable); and social (e.g., hospitals, schools and prisons).  Infrastructure assets operate in an environment of limited competition as a result of natural monopolies, government regulations or concessions.  The stylized economic characteristics of this asset class include the following.

  • Relatively steady cash flows with a strong yield component: Infrastructure assets are generally long lived. Most companies have long-term regulatory contracts or concessions to operate the assets, which can provide predictable performance over time.  As a result, infrastructure assets have the potential to generate consistent, stable cash flow streams, usually with lower volatility than other traditional asset classes.
  • High barriers to entry: Due to significant economies of scale, infrastructure assets are often regulated in such a way that discourages competition. The high barriers to entry often result in a monopoly for existing owners and operators.
  • Inflation protection: Revenues from infrastructure assets are typically linked to inflation and are often supported by regulation. In certain instances, revenue increases linked to inflation are embedded in concession agreements, licenses and regulatory frameworks.  In other cases, owners of infrastructure assets are able to pass inflation on to consumers via price increases, due to the essential nature of the assets and their inelastic demand.

Consequently, the infrastructure asset class may provide investors with a degree of protection from the business and economic cycles, as well as attractive income yields and an inflation hedge.  It could be expected to offer long-term, low-risk, non-correlated, inflation-protected and acyclical performance.

It is also generally believed that infrastructure is, as an asset class, poised for strong growth.  As the global population continues to expand and standards of living around the world become higher, there is a vast demand for improved infrastructure.  This demand includes the refurbishment and replacement of existing infrastructure worldwide and new infrastructure development in emerging markets.

Financing public infrastructure has traditionally been the responsibility of the state.  However, fiscally constrained governments are increasingly turning to the private sector to provide funding for new projects.  As a result, the investment opportunities in this sector continue to grow.

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ETFs in Insurance General Accounts – 2022

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Raghu Ramachandran

Head of Insurance Asset Channel

Introduction

In 2021, U.S. insurance companies added USD 1.5 billion in exchange-traded funds (ETFs) to their general account portfolios.  By year-end 2021, U.S. insurers increased their ETF AUM by 15% from 2020.  This 2021 growth was in line with long-term trends; in the 18 years since 2004, insurance companies have increased their ETF AUM by 15% annually.  Historically, insurance companies have invested in Equity ETFs even though the majority of their assets are in Fixed Income securities, and Equity ETFs still dominate insurance ETF holdings.  However, with the increasing acceptance of Fixed Income ETFs, we saw a significant increase in flows into these ETFs from insurance companies.  Indeed, in 2021, insurance companies added to Fixed Income ETFs while removing funds from Equity ETFs.  In our seventh annual study of ETF usage in U.S. insurance general accounts, we also analyzed the trading of ETFs by insurance companies.  On average, insurance companies traded twice as many ETFs during the year as they held at the beginning of the year.  Overall, 2021 trade volume was relatively flat compared with 2020.  This was primarily because intra-year turnover declined by 24%.

Holding Analysis

Overview

As of year-end 2021, U.S. insurance companies invested USD 45.4 billion in ETFs.  This represented only a fraction of the USD 7.2 trillion in U.S. ETF AUM and an even smaller portion of the USD 7.8 trillion in invested assets of U.S. insurance companies.  Exhibit 1 shows the growth of ETFs by U.S. insurance companies over the past 18 years

ETFs in Insurance General Accounts – 2022 - Exhibit 1

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