Indexology^® Blog

The first quarter was a tough one for equity markets in the region, as a stronger U.S. dollar and the ongoing impact of the COVID-19 pandemic weighed on performance. Despite a 3.1% gain in March, the S&P Latin America BMI lost 5.8% in USD in Q1 2021, while the S&P 500^® gained 6.2%. At the country level, the story was mixed. Mexico and Chile finished the quarter in positive territory, while Brazil, Argentina, and Colombia all declined. Peru was nearly flat.

The currency exchange rate plays an important role in the performance of regional indices. Given the strength of the U.S. dollar, returns measured in local currency were much better. In Q1, the S&P Brazil BMI lost 10.2% in USD but only 3.1% in BRL. Similarly, the S&P Colombia BMI lost 15.7% in USD but only 9.5% in COP. Peru had mixed results, with the S&P/BVL Peru General Index generating a nearly flat return in PEN (-0.7%), but a positive one in USD (2.6%). Chile’s and Mexico’s equity markets performed strongly in Q1, posting slightly higher gains in their respective local currencies than in USD terms. Argentina was the only market in the region for which returns in ARS and USD were negative. Therefore, the cumulative returns in local currency for Q1 of the S&P Latin America BMI (which excludes Argentina) was nearly flat, at -0.09%.

Let’s review some of the more interesting trends (in local currencies) that happened in each market. In Argentina, despite having a tough Q1, the flagship S&P MERVAL Index had strong gains for the one-, three-, and five-year periods with annualized returns of 96.8%, 15.5%, and 29.9%, respectively. It is worth mentioning that market volatility was the highest in this region.

Q1 2021 resulted in negative returns for most Brazilian equity indices, except for the S&P/B3 SmallCap Select Index (3.0%) and the S&P/B3 Low Volatility Index (1.0%). What was exceptional was the longer-term performance of the S&P/B3 High Beta Index, which gained 105.9%, 25.9%, and 39.6% for the one-, three-, and five-year periods, respectively. The S&P/B3 Ingenius Index, based on international technology-driven companies listed on NYSE or NASDAQ and on B3 as BDRs, continued to do well despite currency differences (11.0% BRL).

The Chilean market finally made a comeback, generating strong performance in the short term with the flagship S&P IPSA gaining 17.3% in Q1. The Construction and Real Estate sectors, along with the Financials sector, topped the leader board as the best-performing industries in Chile.

Colombia was the worst performer for Q1, with important companies like BanColombia SA and Grupo de Inversiones Suramericana SA losing significant price appreciation when comparing stock prices from Dec. 31, 2020, to the end of March 2021. For the 12-month period, however, the S&P Colombia Select Index maintained a 24.2% gain.

Mexico’s equity indices displayed strong performance across short- and long-term periods. Mexico’s flagship index, the S&P/BMV IPC, gained 7.2% for Q1. Two indices that capitalized on the recent recovery and had the highest returns in Q1 were the S&P/BMV IPC 2X Leverage Daily Index, an index designed to reflect 200% of the return (positive or negative) of the S&P/BMV IPC, which gained 14.2% for the quarter, and the S&P/BMV IRT SmallCap, which tracks the performance of 14 small-cap stocks, and yielded 9.9% in Q1.

Another index that performed well was the S&P/BMV Total Mexico ESG Index (6.9% for Q1). This index serves as a broad market benchmark that considers sustainability screens in the selection and weighting processes of the components.

The Peruvian equities market resulted in decent returns for Q1, which helped sustain strong returns for the longer-term periods; however, the stronger U.S. dollar generated mixed returns. The S&P/BVL Peru Select 20% Capped Index, which was relatively flat for Q1 (0.4% in PEN and -2.9% in USD), gained 58.8% in PEN and 45.6% in USD for the one-year period ending March 2021. The S&P/BVL SmallCap Index was the local index with the best returns in Q1 (19.4% in PEN and 15.4% in USD).

It has been over a year since the onset of the COVID-19 pandemic. In its path, poverty and inequality have increased in most countries. In addition, the high unemployment rates¹ and upcoming presidential elections in countries like Chile, Ecuador, and Peru and mid-term elections in Argentina and Mexico could create uncertainty and volatility in the coming months. Nevertheless, the Latin American markets are proving to be resilient despite the many challenges they have faced.

For more information on how Latin American benchmarks performed in Q1 2021, read our latest Latin America Scorecard.

¹ Oliveros-Rosen, “Economic Outlook Latin America Q2 2021,” p 15.

In our previous blog, we’ve shown that SPACs tend to be small- and micro-cap companies that have low liquidity. Following the same framework, in this blog we will analyze SPACs’ performance. We found that relative to S&P SmallCap 600®, active SPACs underperformed when seeking the target, delivered abnormal returns during the deal announcement period, and underperformed again post-merger.

SPACs’ Performance Peaks Leading Up to Announcement Day

Exhibit 1 summarizes SPACs’ excess return over the S&P SmallCap 600 post-IPO and post-completion. Exhibit 2 shows how daily excess returns changed 30 days before and 30 days after the deal announcement. Finally, Exhibits 3-6 show the distribution of excess returns. The data highlights the following:

1. Post-IPO, SPACs underperformed the S&P SmallCap 600 (see Exhibit 1). The distribution of the excess return was heavily skewed (see Exhibit 3).
2. SPACs outperformed the S&P SmallCap 600 dramatically upon deal announcement (see Exhibits 2 and 4). Reflecting the market’s general positive sentiment, the percentage of SPACs that outperformed increased toward the deal announcement (see Exhibit 1). The abnormal return observation during the announcement day is consistent with previous research.¹
3. After the deal announcement, the excess return distribution was pushed to extremes, with large positive and negative excess returns observed. The mean excess return, however, was about 0. Holding SPACs 30 days post-deal announcement, in general, led to underperformance versus the S&P SmallCap 600 (see Exhibit 5).
4. Post-deal completion, we observe a heavily skewed distribution of excess returns, with an increasing negative skewness, the further away from completion (see Exhibit 6). This observation is also consistent with previous studies documented that post-merger SPACs are value-destroying to investors.²

We remain cautious in assessing post-merger performance because most SPACs listed in 2020 and 2021 are still looking for targets. As the number of SPACs proliferate, how they perform post-merger will be worth monitoring going forward.

¹ Rodrigues, U., & Stegemoller, M. (2014). What all-cash companies tell us about IPOs and acquisitions? Journal of Corporate Finance, 29, 111-121.

² Lakicevic, M., & Vulanovic, M. (2013). A Story on SPACs. Managerial Finance, 39(4), 384-403. Dimitrova, L. (2017). “Perverse incentives of special purpose acquisition companies, the “poor man’s private equity funds.” Journal of Accounting & Economics (JAE), Vol. 63, No.1, 2017. Klausner, Michael D. and Ohlrogge, Michael, A Sober Look at SPACs (October 28, 2020). Stanford Law and Economics Olin Working Paper No. 559, NYU Law and Economics Research Paper No. 20-48

International equity investors have long participated in the U.S. market, but their interest has often focused on the globally recognized blue chips included in benchmarks such as the Dow® and the S&P 500®. In doing so, they may be missing out on the long-term outperformance of smaller companies; presently, they may also be missing out on a diversification and growth opportunity that is “hidden in plain sight” within the global equity landscape.

The reluctance of international investors to venture down the capitalization scale may be due to concerns over the liquidity of smaller names, or potentially to a perception that smaller-stock allocations required active management (with the disappointing performance that active management often entails). But with low-cost, tradeable products tracking indices like the S&P MidCap 400^® and the S&P SmallCap 600^® being made available internationally, the opportunity set is changing.

In a new paper, we examine the international case for exploring beyond the S&P 500 in U.S. equities. As well as arguing that they can provide diversification, particularly when large-cap concentrations are at relatively high levels, we also argue that the U.S. small- and mid-cap segments may be poised to benefit most from an expected surge in U.S. GDP growth. Of course you should read the full paper here; to whet your appetite, here are our top three takeaways and charts:

1. U.S. small and mid caps are a significant part of the global equity market, larger in size than France and most major European nations.

2. European fund investors have so far made only minimal allocations to smaller U.S. companies, particularly when compared to their weight in the global markets, or when compared to U.S. large cap allocations.

3. Historically, companies further down the capitalization scale have tracked trends in U.S. GDP more closely than their large-cap counterparts. And while the largest American companies outperformed in the latter part of the 2010s, it left U.S. large caps relatively concentrated in a few large, internationally focused names. It’s no coincidence that a return to strong growth expectations for the domestic economy has seen small and mid caps begin their comeback.

For those based in the U.S., the lack of international demand for small and mid caps could imply a structural price discount; for those outside, this may also represent an opportunity to access a return stream largely ignored by their peers. With the growth in liquid, low-cost, index-based products, market participants worldwide are offered new options for broad-based access to a major source of potential diversification and growth.

A CRITICAL DISTINCTION TO BE MADE

When the pandemic began, many investors feared widespread dividend cuts. However, while some companies did cut or suspended their dividends, the damage was largely confined to the pandemic’s early stages. Once the economy began to stabilize, so did dividends. By the end of 2020, approximately three times as many companies in the S&P 500 raised their dividends as cut them.

This distinction in dividend policy had a significant impact on performance. Across the market-cap spectrum, dividend growers outperformed dividend cutters by approximately 20%. Dividend strategies focused on high yield (represented by the Dow Jones U.S. Select Dividend Index) held proportionately more dividend cutters and saw their performance struggle. Dividend growth strategies (represented by the S&P 500 Dividend Aristocrats Index) fared much better.

WHERE IS THE DIVIDEND GROWTH?

Although more companies grew their dividends than cut them in 2020, the rate of dividend growth among large-cap stocks has actually been trending lower for the last several years. And mid-cap stocks fared even worse, posting a dividend decline of roughly 8% for 2020.

Against this backdrop, one obvious place to look for sustainable and increasing income is dividend growth strategies. While dividends for the broad-market indexes were flat or down, S&P Dividend Aristocrat strategies delivered robust rates of dividend growth.

FINDING DURABLE DIVIDENDS IN 2021

Analyzing cash flows can help identify companies capable of producing durable dividends. Over time, companies must create enough cash flow to pay expenses, invest in their business via capital expenditures, service their debt, and (sometimes) return money to shareholders via dividends and buybacks.

Free cash flow (“FCF”) measures the cash left over after a company pays its operating expenses and capital expenditures, and it represents the resources available to pay dividends.

Cash Flows from Operations (CFO) – Capital Expenditures = Free Cash Flow

Free cash flows can be turned into a payout ratio by calculating how much the company’s free cash flows it pays out in dividends.

Dividends / Free Cash Flow = Free Cash Flow Payout Ratio

A lower payout ratio gives companies the flexibility to continue paying and growing dividends, even if cash flows fluctuate. In contrast, companies with high payout ratios have very little flexibility and may have to cut or suspend dividends if earnings and cash flow falter. Dividend growth strategies generally appear better positioned, relative to high dividend yielding strategies, to sustain and grow their dividends.

While the worst of the pandemic’s impact on dividends appears to be behind us, we urge dividend investors to remain vigilant. Making a distinction between dividend growth and high yield strategies had important implications in 2020, and it will remain a key topic moving forward in 2021.

This is not intended to be investment advice. Any forward-looking statements herein are based on expectations of ProShare Advisors LLC at this time. ProShare Advisors LLC undertakes no duty to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Investing is currently subject to additional risks and uncertainties related to COVID-19, including general economic, market and business conditions; changes in laws or regulations or other actions made by governmental authorities or regulatory bodies; and world economic and political developments.

The “S&P 500® Dividend Aristocrats® Index” and “S&P MidCap 400® Dividend Aristocrats Index” are products of S&P Dow Jones Indices LLC and its affiliates. All have been licensed for use by ProShares. “S&P®” is a registered trademark of Standard & Poor’s Financial Services LLC (“S&P”) and “Dow Jones®” is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”) and have been licensed for use by S&P Dow Jones Indices LLC and its affiliates. ProShares have not been passed on by these entities and their affiliates as to their legality or suitability. ProShares based on these indexes are not sponsored, endorsed, sold or promoted by these entities and their affiliates, and they make no representation regarding the advisability of investing in ProShares. THESE ENTITIES AND THEIR AFFILIATES MAKE NO WARRANTIES AND BEAR NO LIABILITY WITH RESPECT TO PROSHARES.

The recently published SPIVA^® Latin America Year-End 2020 Scorecard shows that the volatile environment of 2020, though potentially favorable for high-conviction active managers, did not necessarily translate into success for active managers.

SPIVA scorecards measure the performance of active funds against an appropriate benchmark. For Latin America, S&P Dow Jones Indices began publishing the scorecard in 2014, covering Brazil, Chile, and Mexico.

As of year-end 2020, all categories across all three countries underperformed their benchmarks over the 1-, 3-, 5-, and 10-year periods. These results contrasted those of the SPIVA Latin America Mid-Year 2020 Scorecard, in which Brazilian active managers in the Brazil Equity Funds, Brazil Large-Cap Funds, and Brazil Corporate Bond Funds categories managed to take advantage of the circumstances and outperform over the one-year period (see Exhibit 1).

Median fund managers across all the categories in the report underperformed their benchmarks over 1-, 3-, 5-, and 10-year periods (see Exhibit 2). However, in five out of seven categories, active managers in the first quartile beat their benchmarks over the one- and three-year periods (see Exhibit 3). Top-performing managers in the Brazil Equity Funds category were even able to outperform over the 10-year period.

As evidenced by SPIVA scorecards, the majority of active managers underperform most of the time, especially across the long-term time horizon. Is outperformance luck or skill? Stay tuned for the upcoming Latin America Persistence Scorecard.