IN THIS LIST

The S&P Composite 1500®: An Efficient Measure of the U.S. Equity Market

A Survey of Mexican Insurance Investment Officers

Profitability Screening in Australian Small Caps

Examining Share Repurchasing and the S&P Buyback Indices

The Active Manager's Conundrum

The S&P Composite 1500®: An Efficient Measure of the U.S. Equity Market

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Phillip Brzenk

Senior Director, Strategy Indices

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Aye Soe

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

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Hamish Preston

Director, U.S. Equity Indices

EXECUTIVE SUMMARY

Launched in 1995, the S&P Composite 1500 (hereafter the "S&P 1500") serves as a benchmark indicator for U.S. equity market performance, aggregating price movements of S&P 500®, S&P MidCap 400®, and S&P SmallCap 600.

The S&P 1500 also increasingly serves as a basis for constructing portfolios designed to deliver a "market" return at lower cost than those active managers who offer to beat it. We shall examine the S&P 1500 from both perspectives, as well as examining its merits in comparison to popular alternatives. In particular, we observe that:

  • The sizeable representation of U.S. companies means tracking U.S. equity market performance may be relevant to investors, globally;
  • The S&P 1500 has outperformed the S&P 500, historically;
  • Incorporating smaller companies in a U.S. market benchmark provides a more holistic view of the U.S. economy (see Exhibit 7); and
  • Compared with other U.S. equity market indices, the S&P 1500 avoids relatively illiquid, lower priced, and lower quality stocks (see Exhibit 1).

MEASURING THE U.S. EQUITY MARKET

U.S. companies represented an average of 49.47% of the S&P Global BMI’s capitalization at each year-end between 1995 and 2019, more than five times the average weight of second-place Japan (9.39%). Given that U.S. companies also accounted for over 50% of the market capitalization in most global industries at the end of 2019, many investors may need to turn to the U.S. in order to obtain certain exposures.

The S&P 1500 is designed for investors seeking to replicate the performance of the U.S. equity market, or benchmark against a representative universe of tradable stocks. The S&P 1500 combines three widely followed indices—the S&P 500, S&P MidCap 400, and S&P SmallCap 600—in proportion to their free-float market capitalizations. Hence, the S&P 1500 uses the same inclusion criteria as its three component indices.

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A Survey of Mexican Insurance Investment Officers

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Raghu Ramachandran

Head of Insurance Asset Channel

In February 2020, S&P Dow Jones Indices and the Association of Mexican Insurance Companies (AMIS) conducted our second annual survey of insurance investment officers in Mexico about the state of the local insurance industry.

The objective of the annual survey is to better understand how Mexican insurers invest and allocate their excess capital and how they view issues such as regulation, passive strategies, and the implementation of environmental, social, and governance (ESG) investment criteria. With each annual survey, it is our aim to reflect the current state of the insurance investment landscape from the perspective of the investment decisionmakers.

We administered the survey between Feb. 4 and Feb. 28, 2020, prior to the aggressive spread of COVID-19 in North America and the declaration of the virus as a global pandemic by the World Health Organization. As such, the coronavirus and its potential implications for the financial markets may not have been as top of mind for respondents as they likely would be today. Answers to questions regarding expected returns, adjustments in allocations, concerns, and economic projections represent the respondents' perspectives pre-crisis, under comparatively "normal" market conditions. This report summarizes respondents' perspectives on the following themes:

  • Investments and asset allocation, with a focus on excess capital;
  • Sensitivity to and potential impacts of regulation;
  • The implementation of ESG criteria within the investment process;
  • Indexing and the use of passive strategies and instruments; and
  • 2020 economic indicators.

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Profitability Screening in Australian Small Caps

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Priscilla Luk

Managing Director, Global Research & Design, APAC

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Akash Jain

Associate Director, Global Research & Design

EXECUTIVE SUMMARY

This paper examines the effectiveness of a profitability screen on improving return and reducing volatility and drawdown for Australian small-cap stocks. 

We also demonstrate the benefit of applying a profitability screen to the S&P/ASX Small Ordinaries, the benchmark for small-cap stocks in Australia.

  • On average, 28% of companies in the S&P/ASX Small Ordinaries were unprofitable over the period studied, in contrast to 9% in the S&P/ASX 50. Small-cap companies with positive earnings per share (EPS) historically outperformed the unprofitable companies on both absolute and risk-adjusted bases.
  • The S&P/ASX Small Ordinaries Select is designed to track profitable small-cap companies in Australia. The index’s addition of a profitability screen helped it to outperform its benchmark by 1.2% per year from Sept. 20, 2002, to Dec. 31, 2019.
  • Sector allocation and stock selection effects both contributed to the excess return of the S&P/ASX Small Ordinaries Select, with the sector allocation effect explaining a larger part of it.
  • The S&P/ASX Small Ordinaries Select had higher dividend yield and active profitability factor exposures compared with the S&P/ASX Small Ordinaries.

SMALL-CAP BEHAVIOR IN AUSTRALIA

In 1992, the capital asset pricing model (CAPM) evolved into the Fama & French three-factor model to include size and value as risk factors in addition to market risk, with the aim to help better explain a portfolio’s risk/return characteristics. Inclusion of small-cap companies offers diversification and potential for higher returns.

Exhibit 2 shows the return correlation of various common Australian investment classes.  Australian small caps had return correlations of 0.83 and 0.91 with large and mid caps, respectively.  Among the three size categories in Australian equities, small caps had the lowest correlation with Australian bonds, Australian REITs, and international equities.

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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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Craig Lazzara

Managing Director, Global Head of 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

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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