Indexology^® Blog

After a challenging year in 2022, the U.S. equity market saw a strong turnaround in the first half of 2023, with the S&P 500^® up 17% since year-end 2022. Exhibit 1 shows that the rebound was also observed across the cap spectrum. Returns in the second quarter outperformed the first quarter after the market shook off regional bank concerns earlier this year.

The S&P Core Indices generally underperformed their Russell counterparts in H1 2023. The large- and small-cap indices, in particular, saw relatively large differences. For instance, the S&P 500 underperformed the Russell Top 200 by 2.53% in H1 2023, its second largest H1 underperformance since 1995, only 2020 was larger (-2.59%).

The S&P 500’s underperformance appears to have been largely driven by having less exposure to Information Technology, which has been running hot so far this year. But there were other possible considerations further down the cap spectrum. For example, the S&P SmallCap 600^®’s H1 2023 underperformance may have been driven by the choice of constituents—particularly in Health Care and Financials—rather than differences in sector exposures (see Exhibit 3). The different drivers of relative performance across the cap spectrum have once again demonstrated the importance of index construction and potential impact of stock selection and size exposures.

There was also elevated divergence among style indices in H1 2023. The S&P Value Indices outperformed their Russell counterparts across the cap spectrum, while the S&P Growth Indices underperformed. Notably, the S&P 500 Style Indices posted the largest H1 performance differentials compared to Russell counterparts since 1995—the S&P 500 Value outperformed the Russell Top 200 Value by 7.2%, while the S&P 500 Growth underperformed by 10.9%.

Relative exposure to Information Technology helped to explain the relative performance between S&P DJI and Russell Style Indices. Indeed, Exhibit 5 shows that style indices with higher exposure to the Information Technology sector outperformed in H1 2023. This was particularly the case given that S&P DJI’s December 2022 style reconstitution led to some sector shifts: S&P 500 Value (Growth) had more (less) exposure to Information Technology sectors than its Russell counterpart. Various Russell index-based ETFs are used as proxies for the Russell indices below.

The first half of 2023 saw a recovery among U.S. equities. Information Technology exposure was important in explaining the relative performance of the S&P 500 and S&P Style Indices compared to their Russell counterparts. But stock selection and the size factor also played a role in mid- and small-cap indices. Once again, such performance differences highlight the importance and potential impact of index construction.

¹ We used the following ETFs as proxies for the Russell indices: iShares Russell Top 200 Growth ETF, iShares Russell Top 200 Value ETF, iShares Russell MidCap Growth ETF, iShares Russell MidCap Value ETF, iShares Russell 2000 Growth ETF, iShares Russell 2000 Value ETF, iShares Russell 1000 Growth ETF and iShares Russell 10000 Value ETF.

The global insurance market capitalization has grown significantly over the past three decades, growing from nearly USD 350 billion at the end of 1992 to USD 2.7 trillion as of H1 2023. This growth was accompanied by a shift in global leadership. For example, Exhibit 1 shows that European insurance companies made up a greater proportion of the insurance market than their U.S. counterparts in the early 1990s. Nowadays, the U.S. accounts for the majority of the market capitalization, while Europe’s weight has diminished.

The Dow Jones U.S. Select Insurance Index captures an investable portion of the world’s largest insurance market. As with other indices in the Dow Jones U.S. Select Sector Speciality Index Series, the index is designed to measure the performance of selected subsectors of the Dow Jones Industry Classification System (DJICS). Constituents must also meet liquidity and market capitalization thresholds. The index uses a float-adjusted market capitalization (FMC) weighting scheme with some high-level diversification capping rules applied and is rebalanced quarterly in March, June, September, and December.¹

The Dow Jones U.S. Select Insurance Index comprises stocks from the Dow Jones U.S. Broad Stock Market Index that are classified under DJICS as Full Line Insurance, Property & Casualty Insurance and Life Insurance, and excludes companies whose principal business activities are classified as Reinsurance and Insurance Brokers. Exhibit 2 shows that Property & Casualty Insurance is the primary subsector, making up 67% of the index as of June 30, 2023, followed by Life Insurance at 24% and Full Line Insurance as the smallest slice at just 10%.

Insurance companies are typically considered non-cyclical or “defensive” given that the products and services provided by insurance companies are often needed regardless of the phase of the business cycle. The historical performance of the Dow Jones U.S. Select Insurance Index appears to reflect this perspective.

Exhibit 3 shows that, while the Dow Jones U.S. Select Insurance Index posted similar performance to the Dow Jones U.S. Broad Market Index since the end of 1991 (an annualized 9.5% vs 9.9%, respectively), the insurance index outperformed in turbulent environments. For example, the broad market declined by 19% in 2022, while the Dow Jones U.S. Select Insurance Index gained 12%, outperforming by 31%. In H1 2023, the insurance index underperformed, as tech stocks propelled the market higher.

The Dow Jones U.S. Select Insurance Index typically had a lower trailing 12-month P/E ratio than the Dow Jones U.S. Broad Stock Market Index, meaning market participants typically paid less for every dollar of earnings received. The index also had a moderately higher realized dividend yield than the Dow Jones U.S. Broad Market Index, showing that insurance companies paid more dividends relative to their share price.

¹ For further details, please see the Dow Jones U.S. Select Sector Speciality Indices Methodology.

I love this time of year. August vacations are over, the kids are back in school and football season kicks off in the U.S. The Fed took its August “vacation” at the Jackson Hole Symposium, where Jerome Powell’s remarks singularly focused on price stability. Inflation has come down but “remains too high” and the Fed warned it’s “prepared to raise rates further.” As markets prepare for continued restrictive monetary policy, we went back to school to investigate the performance of commodities under a restrictive Fed. Since 1970, the S&P GSCI has achieved average annualized returns of 10.5% compared to just under 1% during periods when the Fed maintained a restrictive policy stance.

As part of its dual mandate, the Fed sets a target inflation rate of 2%. While that measure remains arbitrary, the Fed seeks to achieve this through accommodative or restrictive monetary policy. Using the primary tool of the Fed, we compare the performance of the S&P GSCI when the Fed funds effective rate remains above target inflation for at least 12 months. The S&P GSCI is the leading commodity benchmark, with back-tested history extending for over 50 years. Taking this iconic benchmark, we evaluate index performance throughout this time. There have each been three periods where sustained monetary policy was either restrictive or accommodative, covering 50 of the 53 years since 1970.^[1]

In over two-thirds of the sample, average annualized returns were over 10.5%. This covers the inflationary bouts of the 1970’s, the commodity super cycle of the 2000’s and one particularly short and abysmal year in 2018/2019. Investors of commodity ETFs missed these opportunities, with the advent of the commodity ETF’s taking place during extremely loose monetary policy regimes. Inflation is now the focus of the Fed and commodity performance has picked up.

Charting the current Fed funds effective rate reminds me of Mr. Powell’s view of the Grand Tetons. These towering peaks pierce the Wyoming sky, with a jagged silhouette stretching for 40 miles. The highest peak tops 13,775 feet, while the lowest elevation is well over a mile high. Those peaks rest on top the 3,000 mile long Rocky Mountains with elevations over one and up to three miles high. Like the Tetons, inflation has jutted up and fell from its recent peak but remains elevated. This would explain Mr. Powell’s emphasis on inflation, stating “restrictive monetary policy will likely play an increasingly important role.”

Looking at the history of the S&P GSCI, when the Fed gets defensive, commodities have tended to be a good offense. In this current period of restrictive monetary policy, commodities have produced solid but erratic returns. The S&P GSCI achieved a 22% return in 2022, outpacing all asset classes. Year-to-date, the S&P GSCI has a total return over 5%. Should the Fed remain restrictive, historical commodity returns have proven to be a solid defensive strategy.

^[1] The three years include the current period and times the effective rate did not stay above or below for at least twelve consecutive months.

The S&P 500® performed well from the last rebalance for the S&P 500 Low Volatility Index on May 19, 2023, through the most recent rebalance on Aug. 18, 2023. As Exhibit 1 shows, the S&P 500 was up 4.7% during this period versus a decline of 1.5% for the S&P 500 Low Volatility Index. This divergence tends to happen especially during periods of strong performance and low volatility for the S&P 500. Interestingly, the annualized daily standard deviation over this period for the S&P 500 was a relatively low 10.7%.

As Exhibit 2 shows, trailing one-year volatility decreased for all 11 GICS® sectors as of July 31, 2023, versus April 28, 2023. Measured in absolute terms, volatility decreased the most for the Consumer Discretionary and Energy sectors, which fell 6.8% and 5.4%, respectively. As of July 31, 2023, Energy, Communication Services, Consumer Discretionary, Information Technology and Real Estate were the top five most volatile sectors in the S&P 500, with daily realized volatilities of approximately 29%, 27%, 26%, 26% and 23%, respectively.

Amid the overall decrease in volatility, the S&P 500 Low Volatility Index’s latest rebalance brought some changes to sector weights. The latest rebalance shifted an additional 1.5% weight to the Consumer Staples sector, which further solidified its position as the largest sector by weight. Utilities had the largest decline in weight, at approximately 2.9%, dropping it to the third-largest sector by weight. The Consumer Staples, Utilities, Health Care, Financials and Industrials sectors continued to have a combined weight of greater than 90%.

Energy and Materials continued having no weight in the S&P 500 Low Volatility Index. The latest rebalance was effective after the market close on Aug. 18, 2023.

Burton Malkiel, author of the book A Random Walk Down Wall Street, asserted, “The facts suggest that successful market timing is extraordinarily difficult to achieve.”¹

Multi-factor indices may be a way of ensuring you are “in the right place at the right time,” participating throughout market cycles without compromising timing or returns.

The S&P DJI Multi-Factor Indices are built on a bottom-up methodology. This means the factor scores are combined to select “all-rounders” that score highly across multiple factors. The S&P South Africa Composite Quality, Value & Momentum (QVM) Multi-factor Index utilizes the Quality, Value and Momentum factors. The illustration below shows the metrics used in the scoring for each individual factor.

To be eligible for inclusion in the S&P South Africa Composite QVM Multi-factor Index, the constituents must be members of the S&P South Africa Composite and pass a trading liquidity screen. Multi-factor scores are calculated for each company based on the average for each factor. The top 40 constituents with the highest factor score are included in the index. All constituents are market capitalization times factor score weighted, to a maximum weight of 10%.

The methodology enables various benefits to be built into the index. Stocks are selected within the context of the total combined portfolio and overall exposures to the desired factors may be higher. Additionally, back-tested results show stronger risk-adjusted returns than the index of indices approach.

Multi-factor indices have historically tended to perform more strongly over the longer term on a risk-adjusted basis. This improved dynamic is demonstrated by returns being closer to the top left in Exhibit 2. The S&P South Africa Composite QVM Multi-factor Index is nearer this point than other indices.

We show the S&P South Africa Composite QVM Multi-factor Index returns on a yearly basis with the individual factor returns overlaid in Exhibit 3. The S&P South Africa Composite QVM Multi-factor Index line demonstrates how the individual factor returns are working together over various years to deliver the risk-adjusted return.

The correlations across excess returns between factors are low, which allows for the potential benefits from combining individual factors within the S&P South Africa Composite QVM Multi-factor Index approach.

Exhibit 5 shows the risk-adjusted returns over time for each of the factors. The S&P South Africa QVM Multi-factor Index provides good returns over the long-term with lower tracking error against the S&P South Africa Composite. It also participates well in rising markets but avoids some of the downside in falling markets, reflecting the benefits of the multi-factor approach.

The S&P South Africa Composite QVM Multi-factor Index provides an interesting opportunity to consider for multi-factor indexing in the South African market.

¹ Malkiel, Burton. A Random Walk Down Wall Street. W. W. Norton & Company, Inc. 1973.