Indexology^® Blog

Many investors have a so-called “home bias,” allocating to their domestic market in greater proportion than would be expected based on its representation in global equity markets. Asia-based investors are no exception. Here we present our U.S. equity icons as one potential way to provide diversification for Asian investors.

The breadth and depth of the U.S. equity market means that investors risk overlooking a significant chunk of the global equity opportunity set by under-allocating to U.S. equities, which may result in a large active share compared to a global benchmark. For example, Exhibit 1 shows that the U.S. was nearly three times larger than the entire investable Asian equity market, with smaller U.S. equity segments as large as entire local stock markets. The S&P 500^® makes up nearly half of the pie, with the S&P MidCap 400^®  and SmallCap 600^® being larger than the Australian and Hong Kong stock markets, respectively.

Beyond U.S. equities representing a significant portion of the global opportunity set, their distinct sector weights may help investors to overcome domestic sector biases. Exhibit 2 shows GICS^® sector weights of the S&P Pan Asia BMI and the relative weight compared to the S&P Global BMI and the S&P 500. The S&P Pan Asia BMI’s largest weights are in Financials (17%) and Information Technology (16%), with its smallest weight in the Energy sector, at 3%. Some key differences between the S&P Pan Asia BMI and S&P Global BMI and S&P 500 are that the global and U.S. benchmarks have a larger weight in Health Care and Information Technology and lower weights in Consumer Discretionary, Materials and Industrials.

The performance of U.S. equities may also motivate some to consider incorporating U.S. equities alongside domestic equities. Exhibit 3 shows the cumulative performance, in USD terms, of the S&P Pan Asia BMI versus U.S. equity indices since Dec. 30, 1994. The right-hand bar chart shows the annualized total returns of various single stock market indices against the S&P 500, S&P MidCap 400, S&P SmallCap 600 and DJIA^®. Quite clearly, the U.S. equity indices outperformed, historically.

Exhibit 4 shows that the outperformance of U.S. equities was not driven by currency effects. Indeed, the S&P 500 outperformed single-market indices (as represented by the S&P Global BMI sub-indices) in local currency terms as well.

Exhibit 5a also shows the potential diversification benefit of incorporating U.S. equities: there was a non-perfect correlation with Asian equities over the last 28 years. Exhibit 5b also highlights that several single-market indices rank significantly lower in terms of correlation, with China having a 0.4 correlation to the U.S. since Dec. 30, 1994.

Unsurprisingly, perhaps, incorporating allocations to the S&P 500 could have improved risk-adjusted returns. For example, Exhibit 6 shows the annualized returns and volatility for various hypothetical combinations of the S&P 500 and the S&P Pan Asia BMI. These hypothetical combinations rebalance back to the target weights at each year end.

Portfolios that included some proportion of the S&P 500 posted higher returns than a 100% allocation to the S&P Pan Asia BMI.  The high returns were also achieved at a lower annualized risk.

Check out more research and insights on the S&P 500 and DJIA at https://www.spglobal.com/spdji/en/education/article/comparing-iconic-indices-the-sp-500-and-djia/ and https://www.spglobal.com/spdji/en/education/article/regional-relevancy-of-sp-500-and-dow-jones-industrial-average-futures-in-asia.

Take a closer look at the latest SPIVA results as S&P DJI’s Brian Luke and BlackRock’s Stephen Laipply discuss how indexing works for fixed income, the iBoxx liquidity ecosystem, and what a growing range of passive tools could mean for yield seekers as income returns to fixed income.

In the first quarter of 2023, the best performing of the 17 factor indices featured in our monthly factor dashboard was S&P 500^® High Beta (up 12.5%), while the worst performer was S&P 500 Momentum (-3.2%). This may seem odd at first blush, since both indices are, in some sense, performance chasers—Momentum in absolute and High Beta in relative terms. This admitted oversimplification ignores differences in rebalancing schedules, lookback periods, and risk adjustments, yet investors who wonder about the gap between the two indices’ performance are asking a reasonable question.

Exhibit 1 shows the relationship between the monthly returns of Momentum and High Beta. The historical correlation was an impressive 0.73, as the indices tend to rise and fall together.

This comparison, of course, ignores the impact of the market as a whole on the movements of both factors. Exhibit 2 corrects for this oversight by subtracting the return of the S&P 500 from those of both factor indices. The prior strong relationship evaporates, as the correlation of monthly excess returns is only -0.15. Net of the market’s impact, there is essentially no relationship between the returns of Momentum and High Beta.

In part, this stems from a subtlety in the construction of the two indices. High Beta seeks to measure the S&P 500’s highest-beta stocks. If the market has gone up, presumably the highest-beta stocks will be among the market’s best performers, and therefore might also be expected to turn up in Momentum. If the market has gone down, however, presumably the highest-beta stocks will be among the market’s worst performers, leading Momentum to tilt toward lower-beta constituents. This helps explain the specific differences observed during the first quarter of 2023, following the S&P 500’s 18% decline in 2022.

If this explanation is correct, it suggests a general pattern: when the market has risen, the performance of Momentum and High Beta might be similar; when the market has fallen, their performance is likely to diverge. To test this hypothesis, we formed deciles in our historical database, sorted by the trailing 12-month return of the S&P 500. For each decile, we computed the average subsequent 12-month absolute difference between the returns of Momentum and High Beta.

As Exhibit 3 shows, when S&P 500 performance was in its worst decile (with an average decline of 22.5%), the difference between Momentum and High Beta averaged 39.2%. In the second decile (with the S&P 500 down 2.8% on average), the difference falls to 17.6%. In the other eight deciles (where the S&P 500’s performance averaged 18.3%), the difference between Momentum and High Beta was a comparatively small 10%.

We’ve often written about the importance of the market environment in evaluating factor index performance and in considering factor combinations. It can be no less important in illuminating factor differences.

Global equities ended the first quarter of the year with a gain of 6.9%, as measured by the S&P Global BMI. Meanwhile, Shariah-compliant benchmarks, including the S&P Global BMI Shariah and Dow Jones Islamic Market (DJIM) World Index, also increased during the quarter and outperformed their conventional counterparts by 3.5% and 3.4%, respectively.

Overall, regional broad-based Shariah and conventional equity benchmarks had a positive quarter, despite recent volatility in the banking industry. However, the Pan Arab region declined marginally by 0.5% in Q1, while its Shariah benchmark finished the quarter with an increase of 2.5%.

Drivers of Shariah Index Performance in Q1 2023

Shariah benchmarks outperformed their conventional counterparts during Q1, in contrast to prior quarter returns. Sector composition can provide some explanation for this quarter’s results. Higher exposure to Information Technology stocks within Islamic indices and having no exposure to conventional financial services, including banks, were the main drivers of this outperformance. The Information Technology sector was up 22.6% and represents 29.3% of the index’s weight, driving the highest return contribution among all sectors.

Meanwhile, other sectors experienced double-digit gains, such as Communication Services and Consumer Discretionary, which rose 24.6% and 14%, respectively, in Q1, contributing significantly to the index’s outperformance, despite having a relatively smaller weight compared to other sectors.

Energy and Utilities were the only sectors that decreased substantially during Q1, but the impact was limited by their small weight.

MENA Equities Post Mixed Results in Q1 2023

MENA equities experienced mixed results in Q1, with the regional S&P Pan Arab Composite was down 0.5%. GCC country performance was also mixed, with positive returns for Oman (5.0%), Bahrain (4.9%) and Saudi Arabia (1.6%), and losses in the UAE (-5.2%), Kuwait (-3.5%) and Qatar (-1%).

For more information on how Shariah-compliant benchmarks performed in Q1 2023, read our latest Shariah Scorecard https://www.spglobal.com/spdji/en/documents/performance-reports/scorecard-sp-shariah-djim.pdf

This article was first published in IFN Volume 20 Issue 15 dated April 12, 2023.

After 83% of euro-denominated pan-regional equity funds failed to outperform the S&P Europe 350^® in the 10 years leading up to the start of 2022, last year brought an intriguing change in the market winds, including the end of near-zero interest rates and, along with it, higher hopes for stock-picking. There was higher dispersion and, with value stocks beating their peers, there were certainly opportunities for outperformance for those managers paying attention to fundamentals.

As it turns out, the year may well go down as one to forget for most active European equity managers, particularly in the pan-European equity category—in which 87% and 83% of funds underperformed in the euro-denominated and pound sterling-denominated categories, respectively.

While most major markets finished the year with declines, for managers with a “go anywhere, do anything” approach, there were also stark opportunities to generate relative value. Even in adjacent categories—large- and small-cap U.K. equities, for example—there were significant differences in performance. Exhibit 1, reproduced from the scorecard, summarizes full-year 2022 performance across a range of popular fund benchmarks.

Against this backdrop, Exhibit 2 summarizes the one-year underperformance rates across all the fund categories included in the year-end 2022 scorecard.

The scorecard also provides a raft of further data and analysis on the market conditions that accompanied such performance, as well as deeper statistics on the performance of actively managed funds. Readers can also dig deeper into the short- and long-term data on actively managed fixed income funds—included in our European scorecard for the first time this year—in a supporting blog by the report’s main author.

However, it is sometimes worth stepping back from the granular data to make a broader, simple observation, and there is a clear one hinted at by the SPIVA Europe Year-End 2022 Scorecard. In short: while volatile and falling markets might offer active managers greater opportunities to add value, there is no guarantee that they will be able to do so. As compared to European active managers in particular, the year-end 2022 scorecard adds to a growing library of evidence that, contrary to the common conception, an index-based approach to investing can be far better than “settling for average.”