Indexology^® Blog

The market standard commodities benchmark, the S&P GSCI, crushed it in 2021, rising 40.35% and outpacing other similar commodity indices and asset classes, as high and rising inflation provided a great backdrop for this inflation-sensitive asset class. Commodities finished strong in December, rising 7.59% over the month as energy bounced back and Omicron COVID-19 variant concerns were brushed aside, with global demand still humming. Supply chain bottlenecks are slowly easing, but freight costs around the world continue to be elevated, contributing to higher commodity prices.

With the highest weight in the S&P GSCI, the S&P GSCI Energy was responsible for most of the strong performance seen in December and throughout 2021. Every petroleum-based commodity rose by double-digit percentages in December and by at least 58% throughout the year. A combination of strong global demand and reduced oil production due to climate concerns helped petrol to post its strongest yearly performance since 1999. On the other hand, the S&P GSCI Natural Gas continued its decline, posting another 17.57% drop in December as warmer weather reduced demand for one of the main ways to heat buildings in the northern hemisphere.

The S&P GSCI Industrial Metals finished the year strong by rising 5.02% in December. The S&P GSCI Aluminum rose the most in 2021, by 38.43%. In a similar narrative to energy-related commodities, aluminum mining and production (which is typically carbon intensive) was curtailed while demand remained strong, especially for electric vehicles. This green transition friction caused prices to outperform the other industrial metals throughout the year. The S&P GSCI Zinc was the second-best performer, rising 28.03% in 2021 and showcasing an exceptionally strong December rise. Supply disruptions for aluminum and zinc are forecast to continue, with exchange warehouse inventories already low and more metal due to leave particularly from the London Metal Exchange.

The S&P GSCI Agriculture rose 24.70% in 2021. The most liquid corn, soy, and wheat commodities saw positive gains for the year, as weather-related supply disruptions were seen throughout the year, and demand came back strong compared to 2020. Incentivized by higher prices, more crop was planted but the demand side continued to prove to be a positive catalyst. The S&P GSCI Cocoa was the only constituent to show negative 2021 performance, at -6.27%. Its other soft commodity cousin, coffee, instead blew past all other agriculture commodities. The S&P GSCI Coffee beat crude oil with a positive 63.71% 2021 performance. It was the best yearly performance for coffee since 2010, the year several major studies were released in North America hyping the cancer-fighting and exercise-performance-enhancing benefits of a cup of coffee.

The S&P GSCI Livestock rose 7.9% in 2021, with lean hogs pulling the weight. Live cattle and feeder cattle prices were flat, but the S&P GSCI Lean Hogs rose 25.06% this year. Demand for pork was strong throughout the year and in another example of inflation everywhere, fast food prices rose considerably as bacon prices moved higher. The cost of a bacon, egg & cheese sandwich may continue to rise, with current high inflation seen broadly.

The S&P GSCI Precious Metals dropped 5.13% on the year as rates moved higher, market volatility came down, and demand for safe havens diminished. Gold’s historically strong inflation hedging ability and safe-haven status were challenged the most this year with crypto becoming prominent, and prices reflected this struggle.

Factor indices have two important uses. First, they can be used as benchmarks to help clients of specialist managers disentangle how much of the manager’s performance is attributable simply to factor exposure, and how much is attributable to the manager’s stock selection beyond the factor. Second, factor indices can be used as investment vehicles to “indicize” a factor or set of factors, thereby delivering in passive form a strategy formerly available only via active management.

Our recently released paper, Factor Indices: A Simple Compendium, describes S&P DJI’s approach to eight factors: value, dividend yield, growth, quality, momentum, size, low volatility, and high beta. For each factor, we ranked the constituents of the S&P 500^® by factor score, sorting them into equal-weighted quintiles, where Quintiles 1 and 5 contain the stocks with the highest and lowest factor exposure, respectively.

Taking value as an example, Exhibit 1a shows that the cheapest quintile of value stocks handily outperformed the others over time. Quintiles 2-4 are relatively close together, with Quintile 5 trailing. In contrast, Exhibit 1b shows that the quintile analysis for momentum supports an exclusionary approach to portfolio construction, as Quintiles 1-4 are clustered together, while Quintile 5 underperformed significantly. These results show that the performance of quintiles varies across factors; this has important implications for index design. 

Factor performance also varied across different market regimes. Exhibit 2 shows that Quintile 1 of value, size, and high beta outperformed during rising markets, while Quintile 1 of dividend yield, quality, momentum, and low volatility outperformed during down markets, highlighting their defensive characteristics.

Exhibit 3 allows us to make several other observations about these factors. For the period from 1991 through 2020, Quintile 1 of value, size, and high beta were more volatile than their Quintile 5 counterparts. Looking at Quintile 1 across factors, low volatility had the highest Sharpe Ratio, and quality had the highest Information Ratio. The average market cap of Quintile 1 was greater than that of Quintile 5 for dividend yield, growth, quality, momentum, and low volatility, illustrating a large-cap bias.

Understanding performance differences across factor quintiles is critical to understanding index performance and optimizing index construction.

The history of active investment management is, for the most part, a history of failure and frustration. Most active managers underperform most of the time, and success in one period seems not to predict subsequent success. We have long argued that active underperformance is not coincidental—it happens for identifiable and understandable reasons, and is therefore likely to continue.

But—most of the time is not all of the time, and most active managers are not all active managers. Some market environments may be more conducive to relatively favorable (or, to be precise, relatively less unfavorable) active performance. As I write in mid-December, 2021 is far enough advanced for us to attempt some informed speculation about what SPIVA^® will reveal when the final results are in.

There are both positive and negative signals about the prospects for active management:

• One of the most consistent challenges for active managers arises because, in most years, most stocks in the S&P 500^® underperform the index. Returns are typically driven by a relatively small number of strong performers, which pull the index’s return above that of most of its constituents. Through the end of November, this was precisely the situation in the S&P 500: the index was up 23%, versus a gain of only 19% for the median stock. Only 42% of index members outperformed through the first 11 months of the year. Needless to say, fewer outperformers make for more challenging stock selection.

• Strong markets historically have been somewhat more challenging for active managers; this is particularly true when the strong market is driven by some of the index’s largest names. Exhibit 2 shows us that the largest 50 stocks in the S&P 500 are comfortably in the lead for 2021. While it’s relatively difficult for active managers to overweight the largest names in their benchmark index, the reverse is not true. In fact we’ve found that large-cap managers tend to do better in periods when the superior performance of mid- or small-cap names gives them a chance to “cheat” (I use the term lovingly) down the cap scale. Not this year—although the performance of larger names may give mid- and small-cap managers an edge.

• On the other hand: SPIVA data suggest that most active managers typically underweight lower volatility, low beta stocks; when Low Volatility underperforms, or High Beta outperforms, active results tend to improve. Through November 30, the S&P 500 Low Volatility Index was up 13% for the year, while the S&P 500 High Beta Index had risen 36%. The gap has narrowed in December, but so far this signal augurs well for active managers.

• Dispersion began the year at a relatively modest level, but has recently begun a noticeable rise, closing November well into the top quartile of its historical range. Although dispersion tells us relatively little about the success of active managers as a group, heightened dispersion suggests that the range of active outcomes will be greater than usual. The best active performers should shine, as the value of stock selection skill rises when dispersion is high.

Readers can form their own opinions about the proper balance of these observations. Recognizing the hazard intrinsic to all predictions, my guess is that when we draw a line under 2021, active underperformance, at least for large-cap U.S. managers, will persist.

Of course, the conditions that make active management more or less difficult can change. If, e.g., 2022 sees a declining market, with megacaps and lower volatility names leading the way down, it’s conceivable that active underperformance could become less prevalent. That may be cold comfort to the active management community and its customers—but sometimes cold comfort is all the comfort there is.

The Canadian equity market has had an exceptional 2021. One of the distinctive quirks of low volatility indices is that their relative performance typically suffers when their absolute performance is at its best, a pattern that we saw again this year. The S&P/TSX Composite Index was up an impressive 22.0% YTD through Dec. 16, 2021. In this environment, the S&P/TSX Composite Low Volatility Index has done remarkably well, lagging the S&P/TSX Composite by only 2.6% for a 19.4% gain. A defensive strategy designed to offer protection in bad times will typically not outperform (or even keep pace) in great times. The S&P/TSX Composite Low Volatility Index has done a better job at keeping up in 2021, capturing 88% of the S&P/TSX Composite Index’s total return versus its historical average of 66% monthly upside capture.

Strong markets generally imply calm volatility levels, and Exhibit 1 shows that volatility declined in the last three months across all sectors of the S&P/TSX Composite Index.

In the latest rebalance for the S&P/TSX Composite Low Volatility Index, effective at the close of trading on Dec. 17, 2021, the biggest allocation shift came from the Industrials and Real Estate sectors; the former gave up 5% and the latter gained 4%. Exhibit 2 shows that Financials and Real Estate, each with a 26% weight, are currently the two biggest sectors of the low volatility index. Health Care, which had disappeared from the index a year ago, has reappeared with a 2% weighting.

This piece originally appeared on Risk.net.

The dust has now settled on the 2021 UN Climate Change Conference (COP26). Did the gathering of almost 200 nations succeed in putting us on a path towards limiting warming to 1.5°C?

COP26 concluded with the signing of the Glasgow Pact, which agreed to “keep 1.5°C alive.” Some of the agreements made include strengthening 2030 emissions reduction targets, annually revising these targets and a “phase-down” of coal.

However, post-COP26, many felt an air of deflation. Alok Sharma, president of COP26, said: “We’re all well aware that, collectively, our climate ambition and action to date have fallen short on the promises made in [the Paris Agreement on climate change].”

Some areas of concern

There was a lack of visible commitment and priority from some of the world’s largest polluters. Notably absent were national leaders from China and Russia, the largest and fifth-largest contributors, respectively, of national carbon dioxide emissions. However, China did issue a surprise declaration on Enhancing Climate Change Action in the 2020s in partnership with the US.

There is a legacy of failed pledges – most famously the unfulfilled pledge for $100 billion in climate finance for developing nations by 2020. It is therefore unsurprising that headline-grabbing pledges made in the first week of COP26 have been overshadowed by inevitable questions around whether they will be realized. Then there is the failure of some countries to commit to net zero by 2050. India’s commitment to reach net zero by 2070 was a notable announcement at COP26. A significant step, certainly, but 2070 net-zero commitments will not restrict warming to 1.5°C.

Reasons for optimism

There were many pledges and commitments made at COP26. In addition, COP26 provides a platform for smaller nations. Though the limelight focuses on high-profile politicians and the crucial pledges of large nations, the conference is an important forum to also hear the pleas of smaller nations that may produce little in terms of greenhouse gas emissions, but may face the negative consequences of climate change.

COP26 represents a great opportunity, not just for official delegates from nations to gather but also for the wider community to lobby for change. For example, the Fairtrade Foundation supported the participation of a delegation of farmers whose livelihoods are threatened by climate change. Local campaigners demanded climate action from politicians.

Climate change is climbing agendas, and this rise is facilitated by high-profile events such as COP26. Climate issues are now covered more comprehensively in the media and are better understood by the wider population, and there is broad support for the idea that action needs to be taken.

Many companies have, for some time, recognized their ESG responsibilities. It is positive to see segments of the private sector demonstrating an understanding of the risks and opportunities specifically regarding climate change and committing to net zero by 2050. During COP26 there was a notable announcement through the Glasgow Financial Alliance for Net Zero (GFANZ) to commit more than $130 trillion of private capital to transform the economy to align with net zero.

What does this mean for indices?

As a provider of climate benchmarks, we closely follow developments at all UN Climate Change Conferences and evolving investor requirements. Increased demand from asset owners and commitments made by asset managers to account for climate change in their portfolios result in more interest surrounding net-zero-aligned indices.

The S&P PACT indices (S&P Paris-Aligned & Climate Transition Indices) are 1.5°C-aligned and available in several regional exposures, with the S&P UK Net Zero 2050 Paris-Aligned ESG Index being the most recent addition.

S&P DJI is committed to providing transparency on the methodology of its indices and regularly discloses how the sustainability objectives of its S&P PACT Indices are met.

Time will tell if COP26 will be remembered as a success. In the meantime, S&P DJI will continue to produce rules-based indices that align with a 1.5°C scenario to help investors on the path to net zero.