Indexology^® Blog

What does the S&P 500 liquidity ecosystem means for investors? S&P DJI’s Craig Lazzara and State Street Global Advisors’ Rob Forsyth take a closer look at the global reach of this U.S. icon.

https://www.youtube.com/watch?v=HESzJUbAjbg

Learn more:  https://www.spglobal.com/spdji/en/research/article/a-window-on-index-liquidity-volumes-linked-to-sp-dji-indices/

When we think about reversals in the market, we likely think of brief turnarounds in performance.  But what if it’s more? What makes a reversal turn into a recovery is a full-fledged long-term improvement in performance.

We can apply this logic to Equal Weight’s recent experience.  After consistent underperformance since April 2017, the S&P 500^® Equal Weight Index experienced a reversal in the past two months, outperforming the S&P 500 by 2% in October and by 3% in November.  As Exhibit 1 shows, Equal Weight reduced its 12-month underperformance versus the S&P 500 by half to 6.2%, compared to August, when underperformance had dipped to 13.5%.

This reversal was primarily driven by strength in smaller caps, as Equal Weight has a small-cap bias.  Another tailwind was the recent underperformance of the Technology sector, since Equal Weight has a significant underweight to Tech, which was flat over the past three months, compared to a gain of 4% for the S&P 500.

To provide historical context, we do know that Equal Weight outperforms over the long-term, and that there is a general trend of mean-reversion from observing the peaks and troughs in Exhibit 1.  Equal Weight’s trailing 12-month relative performance versus the S&P 500 has a mean value of 1.2% and a standard deviation of 7.6%.  Of course, on its own this doesn’t tell us whether Equal Weight’s recent performance is a temporary blip or the start of a new cycle of outperformance.  To understand this long-term outperformance and the mean-reversion effect, we ranked the months in our database by the 12-month relative performance of Equal Weight and divided them into deciles.  Then, we analyzed the median subsequent 5-year annualized performance in each of these deciles.

The results in Exhibit 2 show that we indeed see a reversion to the mean over the long-term: Lower decile months tend to outperform in the future, while higher deciles tend to underperform.  Decile 1, or the worst performing decile for Equal Weight, had the best subsequent median 5-year performance, outperforming by 8%.

In addition, Equal Weight has a natural anti-momentum bias, as by definition the strategy sells relative winners and purchases relative losers at each rebalance.  To measure the strength of this bias in the above mean-reversion analysis, we calculated the median 12-month relative return correlations of S&P 500 Equal Weight versus S&P 500 Momentum in each of the deciles.   Exhibit 3 illustrates that Decile 1, in addition to having the best subsequent median 5-year performance, also had the second-greatest negative correlation of Equal Weight versus Momentum.

To put things in perspective, Equal Weight’s relative performance for most of this past year was in Decile 1, and its correlation versus Momentum has been strongly negative, consistent with what we observe in Exhibit 3.  The recent underperformance of Momentum as well as the analysis from Exhibit 2 tell us that times of severe underperformance for Equal Weight can bode well for future outperformance.  Similar episodes have occurred in the past.  Time will tell whether Equal Weight’s recent outperformance moves from a reversal into a sustained recovery. 

Could the range of potential applications for gold be broader than some investors may think? S&P DJI’s Fiona Boal and Jim Wiederhold take a closer look at how and why gold is being put to work in portfolios today.

https://www.youtube.com/watch?v=fJXVL2Rvaz8

Read more:  https://www.spglobal.com/spdji/en/education/article/physical-versus-synthetic-gold-know-your-gold-exposure/

While ongoing market uncertainty has dampened property transactions in Asia and bond yields continue to lag, expanded access to REITs could provide a potential income source for yield seekers in Asia. Samsung Asset Management’s Alex Yang joins S&P DJI’s Priscilla Luk for a closer look at how indexing works for REITs in Asia.

https://www.youtube.com/watch?v=Np171BLgA0w

“Today, the Trump Administration officially left the Paris Climate Agreement. And in exactly 77 days, a Biden Administration will rejoin it.” –Joe Biden, Nov. 4, 2020. ¹

In a crowded field for “standout tweets from a U.S. president or president-elect,” for those of us who have dedicated careers to tackling sustainability challenges, this may be the most memorable tweet of them all.

Now, of course, we don’t want to be too premature in our celebrations. There are still several months until the inauguration of President-Elect Joe Biden and there are practical hurdles that need to be cleared. However, initial signs are promising, with the Biden transition team announcing John Kerry as special envoy on the climate crisis, a position that for the first time will include a seat on the National Security Council.²

What is the Paris Agreement and why does it matter so much that the U.S. rejoins? The Paris Agreement “sets out a global framework to avoid dangerous climate change by limiting global warming to well below 2°C and pursuing efforts to limit it to 1.5°C,³” as recommended by the Intergovernmental Panel on Climate Change (IPCC).

The U.S. is the world’s largest economy and is currently the second-largest emitter of greenhouse gases.⁴ According to Climate Action Tracker, the U.S. pledge for net zero emissions by 2050, along with similar commitments from China, EU, Japan, and South Korea, means a tipping point is being approached that puts the goal of limiting warming to 1.5°C within reach.⁵

However, this is no reason for complacency. Alignment with the 1.5°C goal is not a commitment just for governments. The achievement of such an ambitious goal arguably requires participation from all stakeholders, including investors. Climate change ranks as the “highest priority ESG issue facing investors,” according to the Principles for Responsible Investment (PRI).⁶ Investment portfolios and products may be exposed to climate risks as follows:

• Transitional risks of climate change (e.g., stranded assets, rising carbon prices, etc.); and
• Physical risks of climate change (e.g., sea level rise, hurricanes, etc.)

But it isn’t just climate change risks that investment product providers should consider; there are also opportunities available to potentially finance the transition to a lower-carbon economy.

What are the practical tools available to investment product providers who want to manage the risks and opportunities and align their investment products with the Paris Agreement?

At S&P DJI, we have created two benchmarks that align with the 1.5°C scenario: the S&P Paris-Aligned Climate Indices and the S&P Climate Transition Indices, together known as the S&P PACT^TM Indices (S&P Paris-Aligned & Climate Transition Indices).  The S&P PACT Indices offer an information tool for investment product providers looking to address a number of climate objectives while still staying as close as possible to the underlying benchmark index.

The S&P Paris-Aligned Climate Indices set stricter relative decarbonization objectives of the two benchmarks and include a range of fossil fuel exclusions. The S&P Climate Transition Indices still incorporate significant relative decarbonization objectives but are designed for broader exposure. Crucially, both sets of indices decarbonize at an absolute rate of 7% year-over-year, in line with, or beyond, the decarbonization trajectory from the IPCC’s 1.5°C scenario. From a U.S. equities perspective, the S&P 500^® Paris-Aligned Climate Index and the S&P 500 Climate Transition Index both outperformed the broad U.S. benchmark over a period of one year.

There are of course great challenges ahead. President-Elect Biden now has to consensus build and implement strategies to meet ambitious climate targets. We have already seen major investors taking the lead in aligning their investments to the 1.5°C scenario. Benchmarks such as the S&P PACT Indices are designed to make this vital transition much more feasible.

¹ https://twitter.com/JoeBiden/status/1324158992877154310

² https://www.theguardian.com/us-news/2020/nov/23/john-kerry-biden-climate-envoy-appointment

³ https://ec.europa.eu/clima/policies/international/negotiations/paris_en

⁴ https://www.theguardian.com/us-news/2020/nov/08/joe-biden-paris-climate-goals-0-1c

⁵ https://climateactiontracker.org/press/bidens-election-could-bring-a-tipping-point-putting-paris-agreement-15-degree-limit-within-striking-distance/

⁶ https://www.unpri.org/climate-change. The PRI is a UN-supported international network of investors working together to implement its six aspirational principles.