Indexology^® Blog

The Transportation industry group¹ provides transportation infrastructure as well as services to move people or goods. To track the industry group’s performance, S&P Dow Jones Indices offers the S&P Transportation Select Industry Index, S&P Transportation Select Industry FMC Index, and the Dow Jones Transportation Average. To address potential weight concentration issues in the FMC-weighted index, S&P Transportation Select Industry FMC Capped Index was launched on April 26, 2021. In this blog, we introduce this new index.

Exhibit 1 shows the methodology comparison of the S&P Transportation Select Industry FMC Capped Index, S&P Transportation Select Industry Index, and Dow Jones Transportation Average.

Universe

The S&P Transportation Select Industry FMC Capped Index includes all the sub-industries of the Transportation industry group—Air Freight & Logistics, Airlines, Airport Services, Highways & Rail Tracks, Marine, Marine Ports & Services, Railroads, and Trucking—in the S&P Total Market Index universe.

Size and Liquidity Criteria

The eligible stocks need to meet the float-adjusted market capitalization (FMC) and float-adjusted liquidity ratio (FALR) requirements, as shown in Exhibit 1.

FMC Weighted with Capping

The S&P Transportation Select Industry FMC Capped Index is float-adjusted market cap weighted, subject to 4.5/22.5/45 capping at rebalance dates. That is, an individual constituent weight is capped at 22.5% and the aggregate weight of constituents that individually have a weight greater than 4.5% is capped at 45%. The purpose of capping is to reduce weight concentration in any single security and top holdings.

Exhibit 2 shows the weights at rebalance dates for S&P Transportation Select Industry FMC Capped Index and the corresponding FMC weights if there is no capping applied. The exhibit shows that the capping scheme reduced the concentration of the FMC weight historically.

Large Investable Capacity

The FMC capped index offers large investable capacity. Our analysis shows that even with a hypothetical fund size of USD 20 billion, all constituent holdings would still be below 5% of their corresponding FMC (see Exhibit 3).

Exhibit 4 illustrates the return/risk performance of the S&P Transportation Select Industry FMC Capped Index, the S&P Transportation Select Industry Index, and the Dow Jones Transportation Average Index. The FMC capped index outperformed the other two indices in terms of absolute return and risk³-adjusted return during all other periods except the most recent one-year period.

Conclusion

The S&P Transportation Select FMC Capped Index is designed to track the performance of the transportation industry group and aims to reduce weight concentration issues by applying 22.5/4.5/45 capping. Our analysis shows that this index has a large investable capacity. Moreover, the index has comparable performance with other transportation indices such as the S&P Transportation Select Industry Index and the Dow Jones Transportation Average.

¹ The GICS^® classification standard is used to classify a company by its principal business activity. Each company is assigned to a sub-industry, an industry, an industry group, and a sector.

² FALR is defined as dollar value traded over the previous 12 months divided by the FMC as of the rebalancing reference date.

³ Risk is calculated as annualized standard deviation of monthly total returns.

The S&P BSE SENSEX 50 is designed to measure the performance of the top 50 largest and most liquid companies in India. The index constituents are weighted based on their float-adjusted market cap and must have a minimum annualized trading value of INR 10 billion. The S&P BSE SENSEX 50 is a highly diversified index, and its 50 constituents provide exposure to all 10 major sectors: Utilities, Telecommunication Services, Information Technology, Industrials, Healthcare, Fast-Moving Consumer Goods (FMCG), Finance, Energy, Consumer Discretionary, and Basic Materials.

Exhibit 1 presents a pictorial representation showing the weight of the 10 sectors of S&P BSE SENSEX 50, as of May 31, 2021. We can see that the Financials and Information Technology sectors had the highest representation, at 37.56% and 16.22%, respectively, while the Telecommunications and Utilities sectors had the least representation, at 1.93% and 1.66%, respectively.

The returns of the S&P BSE SENSEX 50 have been promising over the past 10 years. The total returns index value has gone up from 6,095.76 on May 31, 2011, to 20,092.21 on May 31, 2021, reflecting an absolute return of 230%.

From Exhibit 2, we can see that in 8 out of 10 calendar years, the S&P BSE SENSEX 50 posted positive returns. The highest total returns of 33.44%, 31.96, and 29.87% occurred during 2014, 2017, and 2011, respectively. 2011 was the only year during which the index posted a significant negative return of -23.66%.

Exhibit 3 shows the annualized risk/return profile of the S&P BSE SENSEX 50 for 3-, 5-, and 10-year periods. Overall, the index’s returns were promising across all periods observed.

Exhibit 4 shows the top 10 constituents of the S&P BSE SENSEX 50 along with their corresponding sectors. We can see that Reliance Industries Ltd holds the highest weight, at 10.49%, followed by HDFC Bank Ltd at 9.28%. Furthermore, 4 of the 10 major sectors are well represented in the top 10 list.

To summarize, we can state that the S&P BSE SENSEX 50 is a well-diversified, liquid index that has a history of strong performance over the past decade.

After more than a decade of underperformance, and in stark contrast to Growth’s dominance for much of 2020, Value has made an impressive comeback so far in 2021, outperforming Growth around the world, including across the size spectrum in the U.S. In fact, Value’s YTD outperformance against Growth in mid and small caps is the largest it’s ever been as of the end of May, while the S&P 500^® Value’s 9.5% YTD outperformance is the second highest in its history through the first five months of a year.

Smaller companies have also outperformed so far this year, which helps to explain why Equal Weight indices, with their smaller size tilt, have outperformed their cap-weighted parents. But the outperformance of smaller size raises an obvious question: since value-oriented companies are typically smaller than their growth counterparts (see Exhibit 2), is Value’s recent resurgence simply a consequence of its smaller size exposure?

In order to analyze the role of size in explaining Value’s recent returns, S&P 500, S&P MidCap 400^®, and S&P SmallCap 600^® constituents are divided into quintiles based on their market capitalizations at the end of 2020. Quintile 1 contains the largest 20% of stocks (by stock count) in each size segment, while Quintile 5 contains the smallest stocks.

Exhibit 3 shows the proportion of Value’s YTD excess returns that are attributed to selection and allocation effects across the different quintiles in large, mid, and small caps. If size was the only determinant of Value’s relative returns, the allocation effect would equal the total effect: there would be no impact from selecting value-oriented stocks. However, the choice of value-oriented constituents (selection effect) was typically more important than allocations to different size quintiles (allocation effect) and the selection effect accounted for the majority of Value’s YTD outperformance.

As a result, Value’s recent resurgence has been driven by the outperformance of more value-oriented companies rather than by their smaller size. And while we will have to wait and see what happens across the style box in the coming months, many investors may be enjoying riding the value wave for the first time in a few years.

We have previously discussed the impact of Equal Weight’s rebound on its exposure to the momentum factor. We now turn our attention to its exposure to the value factor, as the recovery in smaller caps and value stocks has been an important tailwind for the strategy. The S&P 500^® Equal Weight is typically biased toward the value factor partly because of its size and anti-momentum tilts. Smaller stocks tend to have lower valuations than larger stocks; by definition, at each rebalance the Equal Weight strategy buys the underperformers, which have become less expensive, and sells the outperformers, which have become more expensive.

In Exhibit 1, we calculate the spread of the index-weighted value score for the S&P 500 Equal Weight Index versus the S&P 500. As a result of Equal Weight’s value bias, this spread is generally positive, and we see that Equal Weight’s value tilt has decreased compared to a year ago, as performance has improved.

To understand the historical relationship between value and the performance of Equal Weight, we plot the value score spread alongside Equal Weight’s relative performance in Exhibit 2. As we noted earlier, this spread is almost always positive. Second, we observe a strong inverse relationship; as the value spread between Equal Weight and the S&P 500 widens, Equal Weight tends to underperform, as we saw during the tech bubble. Recently, the spread has decreased, coinciding with Equal Weight’s recovery. This intuitively makes sense, as large caps have become less expensive relative to smaller caps.

To provide further historical context, we group our database into deciles by their rolling 12-month change in value spread, and in Exhibit 3, we plot the average change in value spread on the x-axis, and the average relative performance of Equal Weight on the y-axis. We again see an inverse relationship between changes in Equal Weight’s value spread and its relative performance compared to its cap-weighted counterpart.

The current environment is situated close to decile 1, indicating that Equal Weight has become relatively more expensive compared to its cap-weighted counterpart. Interestingly, a year ago, Equal Weight was positioned at decile 8, highlighting the rapidity of the strategy’s rebound.

While we do not know whether the longevity of the value rally is nearing a peak or how sustainable the recovery of smaller caps is, we can look to history to provide perspective on Equal Weight’s current factor environment. If Equal Weight’s outperformance continues, we can anticipate a further decrease in its exposure to value.

“Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.” – Milton Friedman

 “If we do see what we believe is likely a transitory increase in inflation … I expect that we will be patient.” – Jerome Powell, March 4, 2021

Since the Global Financial Crisis, the U.S. Federal Reserve has actively expanded its balance sheet in an effort to keep markets functioning smoothly and help offset economic downturns. While emergency measures may have been warranted at times, the Fed’s seemingly perpetual support (see Exhibits 1 and 2) has been controversial in many quarters.

The Fed’s go-to counter argument has been that inflation remained well under control, and, in fact, for many years was below their 2% target. While there may be some dislocations in capital allocation, in general, keeping interest rates low makes credit more accessible to individuals and businesses and the lack of inflation limits harm, making easy money policies a net positive.

However, the most recent data showed a dramatic uptick in inflation, with a year-over-year Consumer Price Index (CPI) increase of 4.2% in April 2021 and 5.0% in May 2021—the highest reading since 2008. Even excluding the more volatile food and energy sectors, inflation over the previous year was 3.8% in May 2021, the highest since 1992. As previous periods of high inflation have tended to persist in the ensuing months as Exhibit 3 shows, the whispers that the Fed should begin rolling back their market interventions have become louder of late.ⁱⁱ

The high numbers from the past few releases were often dismissed as a “base effects” anomaly in the data. Since April 2020’s price level was artificially low due to the global shutdown at the beginning of the COVID-19 pandemic, it was merely a statistical artifact that calculating year-over-year inflation from that starting point would be so high.

While this is technically accurate, it overlooks the month-over-month (seasonally adjusted) changes. In the past three releases, the month-over-month changes have been 0.6%, 0.8%, and 0.6%. Excluding food and energy, prices have increased 0.3%, 0.9%, and 0.7%. In other words, if the inflation target remains at 2% per year, the Fed has basically used up its annual inflation “budget” within the past three months alone. Unlike the year-over-year series, the changes over the past three months can’t be ignored as coming from an artificially low starting point.

It remains to be seen whether an alternate explanation of “transitory” will hold and the inflation of the past few months is only due to the reopening of the economy and pent-up demand. The Fed’s USD 7 trillion buying binge may yet finally overcome the disinflationary pressures of technological development, demographic changes, and globalization over the past 30 years.

i The Fed vehemently insists this was not actually quantitative easing. The purchase of short-term Treasuries every month was to offset technical dysfunctions in lending markets and not a change in monetary policy. Nonetheless, the “expand the balance sheet” solution hammer applied.

ii The Fed’s 2% target applies to a different measure of inflation, known as the Personal Consumption Expenditure (PCE). The Fed looks at headline PCE inflation over the long-term but tends to focus on core inflation (excluding food and energy) in the short-term. However, in recent years the Fed has talked up the “trimmed mean PCE inflation rate”, which excludes large movements (both positive and negative). The methodological differences between CPI and PCE do not significantly affect the macro issues presented in this post.