Indexology^® Blog

The S&P GSCI, the world’s leading commodities benchmark, could not escape the volatile markets experienced in February, as the index fell 3.83% for the month. Despite recent declines, inflation remained high, which kept the U.S. Fed steadfast in its rate-hiking campaign, and expectations for a possible easing by year-end 2023 were squashed in the latest Fed commentary. A strong retracement higher of the U.S. dollar from the weakness seen in January put pressure on all major commodities, which are priced in U.S. dollars globally.

Within the petroleum complex, S&P GSCI Heating Oil took the biggest hit, down 9.33% after a flat January. Warmer-than-expected weather in the U.S. played a role in decreasing demand for the crude oil byproduct. Crude oil supply was ample, with no change in OPEC’s production announced and record volumes of crude exports to China and India from Russia’s Pacific terminals. Russian crude exports to northern European countries ceased after EU sanctions took effect on Feb. 5.

The S&P GSCI Industrial Metals fell 7.82% in February with broad weakness across all metals. Despite China’s easing of COVID-19 restrictions, demand from the world’s leading importer of industrial metals has not recovered yet. China’s latest forward-looking Manufacturing PMI reading showed the fastest growth in a decade, however. The S&P GSCI Nickel fell the most among the industrial metals, down 18.27%. The International Nickel Study Group announced that in 2022, the global nickel market flipped from a deficit to a surplus for one of the key metallic inputs to electric vehicles. The London Metal Exchange’s nickel contract is still in question after last year’s spike in prices, leading other exchanges like the CME to announce in February that they would launch an alternative nickel contract by the end of March.

The S&P GSCI Gold gave back all of its gains from January, ending February with a flat YTD performance. The S&P GSCI Silver fell 12.06% in sympathy with gold. Silver prices tend to be much more volatile than gold, to the downside as well as the upside. The pressure from the industrial metals space was also felt with silver’s global demand making up about 50% of its use.

Within agriculture, S&P GSCI Wheat prices fell the most, down 8.20% YTD. According to S&P Global Commodities Insights, global wheat prices are expected to see further declines due to the likely rise in supplies across producer countries such as Australia, Canada and Russia. After a year of tightened supplies from the start of the Russia-Ukraine conflict, supplies are likely to normalize.

The S&P GSCI Livestock rose 1.29% and was the only sector to end the month in positive territory, with feeder cattle and live cattle leading the way. Cattle prices have risen steadily since their low in May 2022 due to a progressively smaller global herd and global demand remaining strong.

Traditional investors think of portfolios (whether active or indexed) as collections of stocks. We can equally well think of portfolios as collections of factors—defining factor in the academic sense, as an attribute with which excess returns are thought to be associated. If we’re correct in assessing these attributes, it should be possible to explain portfolio performance by reference, not to the stocks that the portfolio owns, but rather to the factors that it embodies.

One way to illustrate this is with reference to factor indices.  It’s obvious, e.g., that a well-constructed value index is tilted toward cheap stocks (i.e., toward the value factor), but it’s equally true, if less obvious, that a value index might have other tilts as well—for example, toward smaller companies, or higher yields, or lower quality. If this is true, then the performance of factor indices might be explained, in part, by reference to multiple factor exposures.

We’ve noted before that one of the most salient features of 2022 factor index performance was the reversal of several multi-year trends. Equal weight beat cap weight, Low Volatility beat High Beta, and most strikingly, Value outperformed Growth. The Value–Growth differential was so large, in fact, that it explained nearly 80% of the variance in returns across other factor indices, as Exhibit 1 illustrates.

Exhibit 1, though interesting, relies on data from only 17 factor indices. Some stocks will be represented in several of these indices, while others might not be included in any. What happens if we ask how factor exposure affected performance at the individual stock level?

We can approach this question by ordering the constituents of the S&P 500 by the factors of interest, grouping into quintiles, and then measuring returns by quintile. The difference between top and bottom quintiles (i.e., between the average return of the stocks most exposed to the factor and the average return of those least exposed) gives us a convenient way to summarize each factor’s influence. Exhibit 2 shows results for 2022.

Yield was the year’s strongest factor by far, as the market’s highest dividend payers beat non-payers by nearly 29%. Value was in second place, with defensive stalwarts Quality and Low Volatility filling out the top four places. The difference between the performances of Value and Growth is quite consistent with the observations we made in Exhibit 1.

Other things equal, as granularity increases, the importance of factors declines. An individual stock will be more heavily influenced by idiosyncratic factors than will be a diversified portfolio. Even at the stock level, however, understanding factor exposures can produce useful performance insights.

I confess some superhero powers underwhelm me (really, Hawkeye, arrows?) or stretch credulity further than Hulk’s hyper-elastic jeans. However, one I can appreciate is Mystique, the shape-shifting mutant who constantly alters her appearance to stay one step ahead.

If factors were superheroes, I’d argue the S&P 500^® Momentum Index (“Momentum”) and Mystique share commonalities, both misunderstood and powerful through constantly morphing into something new. As a reminder, the momentum factor refers to the tendency of outperforming stocks to continue outperforming in the near term.

Thirty years after the publication of perhaps the most cited paper on momentum, researchers continue exploring why it works. To some, the momentum premium is simply compensation for risk, while others attribute it to human behavioral biases such as loss-aversion or self-attribution. In other words, markets are made up of people who don’t always act rationally, and many don’t understand momentum. Let’s bust three common misperceptions about momentum using data from the S&P 500 Momentum Index (Mystique-blue in the charts below, naturally).

Myth 1: Momentum Is Just Risky or High Beta Stocks

While the S&P 500 High Beta Index (“High Beta”) selects the 100 highest beta stocks from the S&P 500, Momentum selects constituents with top-quintile risk-adjusted price return momentum scores. Resulting differences between High Beta and Momentum indices have historically led to only a 2% overlap and a -0.54 relative return three-year correlation. Performance also underscores the uniqueness of each factor. Just during January 2023, the performance of High Beta and Momentum differed by 17%—their fourth-highest spread since 2010.

Looking over a longer time horizon, data show an often inverse relationship between excess returns for High Beta and Momentum (see Exhibit 1).

Longer-term performance also highlights the differences (see Exhibit 2).

A keen eye finds that Momentum outperformed on a relative basis for the 2022 calendar year, perhaps busting the second part of Myth #1 that the factor is inherently higher risk. In reality, the S&P 500 Momentum Index selects stocks that rank highly on risk-adjusted performance, leading to an index with annualized risk that has historically been similar to or below that of the S&P 500 (see Exhibit 3).

If momentum indices can actually be constructed with similar or less volatility than the broader market, then we can begin addressing the second myth.

Myth 2: Momentum Only Works in Bull Markets

When the S&P 500 declined 18.1% in 2022, the S&P 500 Momentum Index outperformed, falling 10.5%. Curious about Momentum’s resilience, we examined its average excess performance during one-month periods when the S&P 500 was rising or falling. As seen in Exhibit 4, Momentum outperformed in both on average.

Clearly for momentum to work in different conditions, it must transform as the factor itself moves across different parts of the market. The most market-based among factors, Momentum has a historically high turnover, which leads to our final myth. 

Myth 3: The Momentum Factor Can’t Be Indexed.

Put differently, can indices continue to harness a factor like momentum through time? Affirmation comes from the fact that many “passive” indices (such as factors) are quite dynamic in how they rebalance.

Momentum “shapeshifts,” dramatically changing security and sector weights at rebalances to maintain high exposure to the targeted factor (see Exhibit 5).

Like Mystique taking on different forms, the S&P 500 Momentum Index is always changing by design, evolving in response to market conditions and maintaining a high exposure to the factor along the way.

As the world continues to focus on sustainability and the energy transition, it is understandable that market participants are seeking to incorporate sustainability considerations into their commodities portfolios. To that end, on Feb. 23, 2023, S&P Dow Jones Indices (S&P DJI) launched the S&P GSCI Climate Aware, utilizing a new environmental dataset developed in collaboration with S&P Global Sustainable 1. It is the first broad-based commodity index in the market to incorporate environmental metrics.

The S&P GSCI Climate Aware measures performance through futures of a long-only climate-aligned and climate-transition strategy across the constituents of the S&P GSCI. The index follows a portfolio optimization approach to compute constituent weights by seeking to reduce the environmental footprint of the index, while minimizing weight and sector deviations from the S&P GSCI. The optimized constituent weights are constrained to help maintain diversification, investability and liquidity for the index. The index seeks to achieve a 25% reduction in total environmental impact per dollar invested compared with the S&P GSCI, along with a 5% year-over-year decarbonization target, while maintaining total food production and ensuring land and water environmental impact per dollar invested are no higher than the S&P GSCI. Exhibit 1 provides back-tested performance and summary statistics for the index compared with the benchmark.

As environmental considerations come under the scope, market participants have expressed interest in maintaining diversified exposure to an inflation-sensitive asset in line with the benchmark S&P GSCI, while shifting allocations between commodities that may be substitutes, reflecting as closely as possible behaviors in the physical market that may be central to the transition. As such, the index redefines new commodity “sectors” to reflect the changing dynamics of the global economy, dividing the constituents into three economic sectors based on their impact on the environmental transition and currently available substitutions within each category: energy systems, food supply and other. As anticipated, the new index reallocates weights away from high-intensity fossil fuels to those metals important to the energy transition (see Exhibit 2).

The index utilizes a new set of environmental data—the S&P Global Commodity Environmental dataset—which provides physical and financial impact data on greenhouse gas emissions, water consumption and land use at the commodity level, based on life cycle impact assessment factors and natural capital valuation metrics. More information on the dataset can be found here.

S&P DJI continues to be the leader when it comes to bringing innovative, sustainability-focused index offerings to the market. The S&P GSCI Climate Aware is another example of how we look to drive transparency and incorporate sustainability criteria into our benchmark indices. To learn more, please visit the index webpage, or read about incorporating environmental considerations into commodities indices in our research paper published in February 2023.

On Aug. 1, 2022, S&P Dow Jones Indices (S&P DJI) launched a series of S&P GSCI Freight Indices, the first investible shipping indices of their kind in the market and an expansion of the single-commodity offering of indices based on the S&P GSCI. Refer to this blog for background on the indices.

Freight rates have historically enjoyed higher average returns and are more volatile compared to equity, fixed income and other commodities (Exhibit 1). Interestingly, Panamax freight rates are more volatile than the prices of the commodities they typically transport (mostly agricultural commodities and industrial metals). Monthly and quarterly freight rates have similar statistical properties, reflecting the common fundamentals that drive the market and each sector. At the same time, the front end of the futures curve is more volatile and is driven by short-term factors, including repositioning booms and regional supply-demand imbalances, while long-term rates are less sensitive to those events and thus less volatile.

Cumulative returns suggest that Panamax and Capesize freight rates have historically outperformed other commodity indices as well as other asset classes, on the back of a very strong and buoyant freight market in 2020 and 2021 (Exhibit 1).

As global investors increasingly seek to diversify their investments and look for alternative vehicles to tap into niche market segments, the S&P GSCI Freight index series may be a meaningful gauge of global economic activity, seaborne trade and individual commodity, and geographic market dynamics.

Freight rates reflect the balance between supply and demand. Although strong demand for commodities and subsequently high commodity prices may trigger stronger demand for shipping services, the supply of shipping services moves independently. As a result, freight rates can fall in an environment of expanding commodities demand, if the supply of vessels grows faster than the demand for shipping services. Equally, freight rates may increase in an environment of low commodity demand. For those reasons, the correlation between freight rates and other commodities is historically weak.

This is suggestive of freight rates contributing to the diversification properties of a typical portfolio consisting of commodities and stocks and this is confirmed visually by looking at the shape of the efficient frontier and the position of the Panamax and Capesize base assets, especially the quarterly ones (Exhibit 3).

Global shipping is a unique asset class. In this blog, we demonstrated the low correlation between freight rates and other commodities and the potential benefits of including freight in a diversified portfolio. The introduction of the S&P GSCI Freight Indices offers the opportunity to investors to access this unique asset class and be able to include products tracking these indices in their portfolios.