Indexology^® Blog

What role does index liquidity play in helping market-participants in Asia participate in the U.S. equity ecosystem during Asia’s trading hours? Join S&P DJI and State Street Global Advisors for a practical look at using indices to assess the potential opportunity set.

https://youtu.be/H95Tk2kmMgc

Learn more: Regional Relevancy of S&P 500 and Dow Jones Industrial Average Futures in Asia – Education | S&P Dow Jones Indices (spglobal.com)

Since their debut in 1983, S&P 500 options have grown into the most liquid index options in the market today.¹ In 2005, Cboe introduced PM-settled S&P 500 weekly options (SPXW) to meet market demand for additional trading frequency. The first weekly options expired only on Fridays, with Monday and Wednesday expirations added over time. On April 18 and May 11, 2022, respectively, Tuesday and Thursday expirations were added to complete the suite. Now SPXW options have five expirations a week.

Adding Tuesday and Thursday expirations reflects the increasing popularity of SPXW options. S&P 500 option trading has grown significantly in recent years; in the first quarter of 2022, S&P 500 option average daily trading volume (ADTV) exceeded 1.7 million, five times higher than that of 2005 (~285,000). Of that, SPXW option ADTV topped 1.2 million, about 70% of the total. Among the weeklies, roughly 45% ADTV expires on Fridays, 46% is split between Monday and Wednesday expirations, and the remaining 9% expires on Tuesdays or Thursdays because of holidays and end-of-month expirations.

Adding more expirations will offer more trading flexibility. Demand for short-term expirations has grown drastically since 2020. A Cboe study² showed that in 2021, almost half of trading volume came from options that expired within five business days. Day trading and ultra-short-term option trading have broadly gained popularity. Whether the goal is to adjust exposure to imminent events or target specific risk/return objectives, more expirations allow more precise positioning.

Ultra-short-term options also come handy in option trading strategies. For example, in a calendar spread, a market participant expresses their view through a long position in a longer-dated option and sells a nearer-dated option to finance it. Ultra-short-term options tend to be less noisy compared with longer-term ones, due to their limited time frame. Therefore, participants implementing spread trade may benefit from the increased selection of ultra-short option expirations.

Since its introduction in mid-April, the ADTV of Tuesday-expired SPXW options increased to 211,714 in the first week of May, catching up the ADTV of Monday-expired (303,191) and Wednesday-expired (261,523) options. Five expirations per week is exciting news for market participants and could boost the S&P 500 options trading to a new level.

¹ Cboe. “Cboe Global Markets Monthly Trading Statistics.” https://www.cboe.com/us/options/market_statistics/monthly_volume_rpc_reports/.

² Cboe. “Trading SPXW Options with Expirations Five Days a Week.” April 20, 2022.

I am deeply honored to assume the chairmanship of the Index Industry Association (IIA) this year. Since 2012, the IIA has been a tireless advocate for independent index providers globally. As the IIA celebrates its 10^th anniversary this year, now more than ever, our role in educating people about how indexing has transformed and democratized access to financial markets is crucial.

Indeed, indexing has rapidly evolved over the past three decades, growing from a relatively niche and obscure segment of the global financial market into a mainstream part of investing, retirement saving and generational wealth-building.

Today, global index providers collectively offer roughly three million indices that track and measure the broader markets as well as more targeted market sectors and segments. This means that overall, the indexing industry is ripe for competition and innovation.

Transparency has been a founding principle of the IIA, with its members committing to making index methodologies publicly available. Thanks to transparency and independent indices, there are more data and insights available today to help us better understand and evaluate market risks, returns and opportunities. Indices help investors make informed decisions to meet a wide range of financial goals.

Indices themselves have been around for a long time. Iconic gauges such as the Dow Jones Industrial Average^® (DJIA), the S&P 500^® and many other benchmarks are not only tracking the market’s daily ups and downs but are also reflecting its most pivotal moments. For example, indices have borne witness to the changing fortunes of the corporate world, industry shifts in the global economy and the rise of new companies. Indices reflect the market’s history and longevity and provide an eye toward its future.

The value and benefits that indices and indexing have brought to global markets cannot be underestimated. While independent index providers do not manage money, trade or develop investment strategies, indices are licensed and utilized as building blocks for index-based financial products such as exchange-traded funds (ETFs). The demand for indices and index-based products such as ETFs continues to grow, driven by their transparency, efficiency and low cost.

An S&P Dow Jones Indices study illustrated the strength of savings derived from indexing over the past 25 years. S&P DJI estimated that indexing has generated approximately USD 357 billion in cumulative savings in management fees. This study used three of S&P DJI’s core U.S. equity indices as a sample. If we consider the cumulative benefits derived from all the indices available linked to ETFs and other index-based investment products, the aggregate amount of savings would likely be far higher.

In addition to lower costs, performance is another key driver of the growth of indexing and the shift to index-based or passive investing from active management. S&P DJI has been tracking the performance of actively managed funds versus their respective indices and has found that active managers, which typically charge higher management fees, tend to trail their benchmarks in terms of performance. In the SPIVA^® U.S. Year-End 2021 Scorecard, S&P DJI found that more than 80% of U.S. large-cap funds underperformed the S&P 500 over a 10-year period. Indices and indexing with their cost benefits have contributed to increased market competition. Ultimately, it seems that healthy competition among index providers and a diversity of choice benefit end investors.

Indices and the indexing industry as a whole will continue to reflect the ongoing evolution of global financial markets. Since its founding a decade ago, the IIA has served as a unified voice for the indexing industry and remains committed to maintaining an open and constructive dialogue with a diverse group of market participants and stakeholders.

The IIA and its members recognize their important contributions to and role in the broader financial ecosystem and will continue to uphold the highest standards of integrity and transparency in our industry to promote sustainable global financial markets and foster healthy competition and innovation.

This article was first published on the Index Industry Association website on March 31, 2022, as part of the series Voices of IIA.

The years between 2017 and 2021 were a frustrating half-decade for value investors. The S&P 500 Growth Index advanced at a compound annual rate of 24.1%, more than double the 11.9% return of its Value counterpart. Despite occasional (and sometimes prematurely celebrated) periods of success, Value underperformed Growth in four years of the five (and its win in 2019 was close).

In the first four months of 2022, however, the style winds shifted, as Value (-5.0%) dramatically outperformed Growth (-20.0%). Exhibit 1 puts this difference in historical context, comparing January-April 2022 to all other trailing four-month intervals in our database. The 15% gap between Value and Growth is obviously high by historical standards, and represents a dramatic reversal from recent trends. (As recently as nine months ago, the gap favored Growth by more than 10%.)

Exhibit 2 examines the same data with a 12-month lookback. The acceleration of Value’s performance is nearly as impressive from this perspective. At the end of April 2022, Value was 6.5% ahead of Growth; just five months ago, for the year ending November 2021, Growth was 13.3% ahead of Value.

For either lookback period, the conclusions are clear: Value has outperformed Growth to a historically uncommon degree, and this differential has accelerated quite dramatically in the last year.

What does this portend for the future relative performance of Value and Growth?  Spoiler alert: I don’t really know, but there are at least some reasons to suspect that Value’s advantage may weaken in the near term.  Exhibit 3 compares the current Value-Growth spread to its historical level.

Value’s 15% differential for the first four months of 2022 was not only visibly above average, it’s at the 98^th percentile of all such spreads in our historical data. The only higher readings came in the deflation of the technology bubble more than 20 years ago. Comparing Pure Value and Pure Growth produces much the same result. The trailing 12-month data suggest a similar, if somewhat less extreme, conclusion, with Value’s outperformance just into the top quartile of its history. (Similar analysis for mid- and small-cap style indices show much the same results.)

The fact that a data point is high in its historical distribution doesn’t mean that next month’s observation can’t be equally high, or higher. There’s no guarantee, for that matter, that the distribution is stable, and that the next observation won’t surpass the previous all-time record. That said, history suggests that the torrid outperformance of Value is unlikely to continue, at least in the short term, and that the next big move in the Value-Growth differential is more likely to be down than up.

Similar to active managers, who attempt to identify stocks with above-average performance, investors who use active funds aim to identify managers who will outperform their peers. Our SPIVA^® Scorecards consistently show that most active managers underperform most of the time. But not all funds, and not all the time. How might such outperforming funds be identified in advance?

Notwithstanding the commonly used disclaimer that “past performance is no guarantee of future results,” one obvious place to search is among those funds that outperformed in the past. However, the reliability, if any, of history as a guide to manager selection is critical: examining the persistence of active success helps us disentangle managers with true skill, from those simply visited by good fortune.

Our Persistence Scorecards measure the degree to which historical relative performance predicts future relative performance. One measure included in the report is the proportion of funds that were top quartile (versus their peers) that remained so over various time periods. Sourced from our U.S. Persistence Scorecard Year-End 2021, Exhibit 1 shows that only 27% of top-quartile U.S. large-cap funds from December 2011-December 2016 remained in the top quartile for the next five years, slightly above the 25% rate we’d see if performance were completely random. Meanwhile, U.S. mid- and small-cap funds performed even worse. A miniscule 1% of top-quartile U.S. mid- and small-cap funds remained in the top quartile during a subsequent five-year period, refuting a common assertion that it is easier to sustain outperformance within the smaller-cap space.

More importantly, these performance persistence problems are not unique to the U.S, with similar results across Canadian, European, Latin American and global emerging markets,¹ as illustrated in Exhibit 2.

Extending our time horizon, Exhibit 3 shows there is an exponential decrease in persistence over longer time periods. For example, while 25% of Canadian Small-/Mid-Cap Equity funds maintained their top status over three consecutive years, that number dropped drastically to zero over a five-year period. Funds across regions fared no better, with none of the U.S. Small-Cap, Canadian, Brazil or Mexico Equity funds able to stay in the top quartile over five consecutive years, indicating that when outperformance does in fact occur, it tends to be fleeting. 

Unsurprisingly, the worst-performing funds across regions are likely to end up merging or liquidating. We see in Exhibit 4 that on average almost 40% of fourth-quartile funds globally disappeared over a subsequent five-year period.

The lack of persistence among active managers globally is not a new phenomenon. These results suggest that short-term success, when it occurs, may arise as much from luck as from genuine stock selection skill.

¹ Benchmark is the S&P/IFCI Composite for Euro-denominated Emerging Markets Equity funds.