In This List

The S&P MidCap 400®: Outperformance and Potential Application

A Case for Dividend Growth Strategies

ETFs in Insurance General Accounts 2019

Capturing the Complete China Story: The S&P China 500

Benchmarking Corporate Effectiveness: How the S&P Drucker Institute Corporate Effectiveness Index Captures a More Complete Picture

The S&P MidCap 400®: Outperformance and Potential Application

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Hamish Preston

Associate Director, U.S. Equity Indices

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Louis Bellucci

Senior Director, Index Governance

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Aye Soe

Managing Director, Global Head of Product Management

EXECUTIVE SUMMARY

Mid-cap stocks have often been overlooked in favor of other size ranges in investment practice and in academic literature. Yet mid-caps have outperformed large- and small-caps, historically: the S&P MidCap 400 has beaten the S&P 500® and the S&P SmallCap 600® by an annualized rate of 2.03% and 0.92%, respectively, since December 1994. To better understand the historical outperformance by mid-caps, as well as their potential use within an investment portfolio, this paper:

  • Provides an overview of S&P Dow Jones Indices’ methodology for defining the U.S. mid-cap equity universe;
  • Outlines the so-called “mid-cap premium,” analyzing it from factor and sector perspectives;
  • Shows that active managers have underperformed the S&P MidCap 400, historically;
  • Highlights how mid-caps can be incorporated within a portfolio.

INTRODUCTION

U.S. equity indices have a long history of measuring the performance of market segments. The Dow Jones Transportation Average™, the first index and a precursor to the Dow Jones Industrial Average®, was created in 1884. The inaugural capitalization-weighted U.S. equity index was first published in 1923 and evolved into today’s widely followed 500-company U.S. equity benchmark—the S&P 500.

More recently, after academic literature demonstrated the existence of a size factor, index providers developed benchmarks to track the performance of smaller companies. Among them were the S&P MidCap 400 and the S&P SmallCap 600, launched in June 1991 and October 1994, respectively.

Despite the historical outperformance of mid-cap stocks, they appear to be under-allocated compared to small-caps. Exhibit 2 shows the proportion of assets invested in core U.S. equities, across the large-, mid-, and small-cap size ranges, by U.S.-domiciled retail and institutional funds at the end of 2018. Based on overall market capitalization, we might expect funds to allocate twice as much to mid-caps compared to smallcaps. Instead, the aggregate core allocation to small- and mid-caps is approximately the same: investors appear to have a preference for smallcaps over mid-caps in their core holdings. The data shows this preference is especially true for active funds.

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A Case for Dividend Growth Strategies

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Tianyin Cheng

Senior Director, Strategy Indices

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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 financial crisis.

While traditional high dividend payers have performed strongly in recent years, they have become quite expensive by most valuation metrics. The previous low-interest-rate environment paved the way for many of these businesses to load up on debt to expand their operations, while continuing to pay high dividends. As a result, many of these companies may come under pressure when rates rise.

Stocks with a history of dividend growth, on the other hand, could present a compelling investment opportunity in an environment of potential volatility and rising rates. 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. 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 UK, Pan Asia, and Japan.


WHY DIVIDEND GROWERS?

Quality

Dividend growth stocks tend to be of higher quality than those of the broader market in terms of earnings quality and leverage. Quite simply, when a company is reliably able to boost its dividend for years or even decades, this may suggest it has a certain amount of financial strength and discipline.

Looking at the S&P High Yield Dividend Aristocrats, while the hurdle for index inclusion is 20 straight years of increasing dividends, the index average is 36.7 years. Additionally, there are eight constituents with over 56 consecutive years of dividend increases.

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ETFs in Insurance General Accounts 2019

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Raghu Ramachandran

Head of Insurance Asset Channel

INTRODUCTION

In our last report, we showed that in 2017, insurance companies increased their use of exchange-traded funds (ETFs) by a significant amount (37% year-over-year). In 2018, insurance companies continued to increase their use of ETFs and, in spite of a market correction in the Q4 2018, held ETF assets in line with long-term growth trends. Furthermore, in 2018, the industry also displayed a divergence in their investment patterns—with companies that had previously been slow to adopt ETFs increasing their usage, and other companies, which in the past had grown ETF usage rapidly, retrenching. A divestment from Smart Beta ETFs, in particular, caused a drag on the overall share ownership and AUM of insurance companies invested in ETFs. In our fourth annual analysis of ETF usage in insurance general accounts, we explore the changing dynamics and current usage of over 1900 companies in this market.

OVERVIEW

As of year-end 2018, U.S. insurance companies had USD 26.2 billion invested in ETFs. This represents a tiny fraction of the USD 3.4 trillion of ETF assets under management (AUM) and an even smaller portion of the USD 6.3 trillion in admitted assets of U.S. insurance companies. While ETF AUM steadily increased over the prior six years, in 2018, the AUM of ETFs in the industry declined for the first time since 2011. In 2018, U.S. insurance company ETF AUM decreased by 3% from the prior year. However, usage still showed a double-digit compound annual growth rate (CAGR) over the 3-, 5-, and 10-year periods.

The last quarter of 2018 had marked downturn in the equity and fixed income markets. The S&P 500 dropped 14% in the 4th quarter; a week before year-end the S&P 500 was off 20%. On December 19th, 2018 the Federal Reserve increased the Fed Funds rate for a fourth and last time in 2018. And even though 10-year Treasury and corporate yields fell during the quarter, corporate spread increased by a larger amount in the Q4 2018. To test if market volatility in Q4 2018 depressed the year-end AUM numbers, we also looked at the number of shares held by insurance companies. Unlike AUM, the number of shares of ETFs used by insurance companies continued to increase in 2018.

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Capturing the Complete China Story: The S&P China 500

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Priscilla Luk

Managing Director, Global Research & Design, APAC

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Liyu Zeng

Director, Global Research & Design

The S&P China 500 captures a more complete picture of the Chinese economy than other segmented China equity indices. This paper discusses the demand for and objective of the index and reviews its construction, characteristics, and historical performance in comparison with other onshore and offshore China equity indices.

EXECUTIVE SUMMARY

  • China is one of the world’s largest economies and is experiencing rapid capital market growth. Chinese equities will likely remain an essential part of long-term investments globally.
  • Offshore-listed shares have represented as much as 34% of the total Chinese equity market, and they have gained increasing traction among global investors who seek exposure to the Chinese economy but are restricted from onshore market investment.
  • There is an increasing demand for benchmarks that integrate Chinese onshore and offshore listings. The introduction of various domestic and foreign investment schemes, as well as stock connect programs, have broadened capital flows between domestic and international markets.
  • The S&P China 500 is designed to measure the performance of the top 500 companies in China. The index includes companies regardless of their place of listing, thereby reflecting a more complete China story than other segmented China equity indices.
  • As the majority of leading Communication Services companies are only listed offshore, and the S&P China 500 is designed to approximate the sector weights of the broad market, the S&P China 500 is less concentrated in the Financials sector and more tilted to the Communication Services sector than the onshore China indices.
  • Benefiting from more diversified sector, exchange, and currency exposures, performance of the S&P China 500 was less volatile than the onshore China indices, while recording slightly higher riskadjusted return over the long term.

THE RISE OF CHINA AND THE NEW G2

There is little room for doubt regarding the growing importance of China in the global economy. China’s nominal GDP reached USD 13.4 trillion in 2018, representing 15.8% of the world economy. It is second only to the U.S., which had a GDP of USD 20.5 trillion in the same year, representing 24.2% of the world economy. China leaped into the new G2 and replaced Japan as the world’s second-largest economy in 2009. Its 2018 GDP was more than double that of Japan, which is in third place, with a 2018 GDP of USD 5.0 trillion.

From 2014 to 2018, China’s real GDP grew at an average rate of 6.9% year-over-year, and the IMF expects this to continue growing at an average annual rate of 5.9% from 2019 to 2023, which would still be much higher than the growth rates of developed countries.

Judging from the purchasing power parity GDP, China represented 18.7% of the world economy in 2018 according to IMF estimates, surpassing the U.S., which represented 15.2% of the world economy in the same year.

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Benchmarking Corporate Effectiveness: How the S&P Drucker Institute Corporate Effectiveness Index Captures a More Complete Picture

EXECUTIVE SUMMARY

  • Since the 1970s, U.S. corporate executives have emphasized shareholder value over stakeholder capitalism. This has lately come to be seen as overdone and unwise for a company’s longterm benefit.  The intangible aspects of corporate performance emphasized by stakeholder capitalism are important factors in value creation.
  • The Drucker Institute created an intangibles-focused model based on the principles of management theory’s definitive thinker, Peter Drucker, to assess corporate effectiveness in five dimensions: employee engagement and development, customer satisfaction, innovation, social responsibility, and financial strength.
  • S&P Dow Jones Indices has combined the Drucker Institute’s four non-financial dimensions with S&P DJI’s definition of financial quality, the quality factor, to provide a holistic approach.
  • The S&P Drucker Institute Corporate Effectiveness Index calculates a combined average score for each stock in the S&P 500®, then further selects the stocks with the best blend of combined average score and consistency across dimension scores.
  • The index exhibits an improved risk/return profile compared with the S&P 500 and offers a uniquely differentiated approach to capture companies that reinvest in stakeholders.

INTRODUCTION

This paper details the investment rationale and the construction of the S&P/Drucker Institute Corporate Effectiveness Index. This index is designed to measure the performance of companies in the S&P 500 using the Drucker Institute’s holistic model for valuing corporate intangibles based on managerial effectiveness.

The Drucker Institute is not alone in its work in this area. Among the most prominent current players is the Embankment Project for Inclusive Capitalism (EPIC), led by Ernst & Young and 19 of the world’s largest asset managers and owners, including Vanguard, State Street, and CalPERS. In 2018, EPIC wrote, “Nearly two decades into the 21st century, businesses worldwide are still reporting to financial markets based on accounting principles and concepts that were first codified in accounting standards in the 1970s to record financial transactions...Today, it is not uncommon that as little as 20% of a company’s value is captured on its balance sheet—a staggering decline from about 83% in 1975.”2

The EPIC report is a reaction to the period between the early 1970s and today, when shareholder capitalism overtook stakeholder capitalism as the most profitable business principle for corporations and their investors. From the 1940s through the 1970s, America’s leading executives spoke frequently about their responsibility to address the needs of all of their constituents. 3 However, by the early 1980s, buoyed by the theories of the University of Chicago’s Milton Friedman,4 the University of Rochester’s Michael Jensen,5 and other academics, “maximizing shareholder value” became the new standard.

As shareholder primacy took hold across the business landscape, evaluation of corporate performance was boiled down, in many respects, to a single number: a company’s daily share price. Although some still applaud “maximizing shareholder value” as consistent with a company flourishing over the long run, 6 this mindset often prompts executives to behave in short-sighted ways that reward them for trading long-term growth for short-term returns. 7

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