Indexology^® Blog

Since 2013, our SPIVA^® Australia Scorecards have shown that the majority of actively managed Australian equity funds have typically underperformed the S&P/ASX 200. According to the recently published SPIVA Australia Mid-Year 2023 Scorecard, 55% of Australian Equity General fund managers lagged the S&P/ASX 200 in the first half of 2023. 

Results for some fund categories were bleaker, with 74% of International Equity General fund managers underperforming the S&P Developed Ex-Australia LargeMidCap in the first half of 2023. We can use style bias, which plays a major role in explaining active manager outperformance, to disentangle this mixed set of results. For example, in our SPIVA report, we found that domestic equity managers may have benefited from exposure to overseas markets, which have outperformed Australian large caps so far this year.

However, style bias can be a double-edged sword, as Australian international equity managers might have faced headwinds from the outperformance of the U.S. relative to other international markets. In Australian dollar terms, the S&P 500^® outperformed the S&P Developed Ex-U.S. LargeMidCap¹ by 5% over the six-month period ending in June. This is a moderate degree of relative strength by historical standards, as we observe in Exhibit 1: 2013, 2014, 2016 and 2021 were years of significant U.S. outperformance in which, perhaps not coincidentally, we also reported the highest international active fund underperformance rates of any SPIVA report, suggesting a possible aggregate underweight to U.S. equities relative to the benchmark.²

Meanwhile, Australian Bonds funds performed relatively better than their large-cap equity counterparts, with a majority outperformance of 55%. Again, perhaps venturing outside of Australia to gain credit exposures played a favorable role. Exhibit 2 illustrates that active Australian Bonds funds have tended to outperform when globally domiciled or issued Australian dollar-denominated corporate bonds of similar credit quality have performed well relative to their locally issued peers. As of mid-year 2023, the S&P Australia Investment Grade Corporate Bond Index outperformed the benchmark S&P/ASX Australian Fixed Interest 0+ Index by 1%.

Style biases come in many forms and can help explain the likelihood of active outperformance across both equities and fixed income markets. Understanding these biases and distinguishing them from true security selection skill may provide valuable insights for Australian asset owners when making manager selection decisions.

The author would like to thank Grace Stoddart for her contributions to this post.

¹ S&P Developed Ex-U.S. LargeMidCap had a 6% weight in Australia as of August 31, 2023.

² S&P Developed Ex-Australia LargeMidCap had a 68% weight in the U.S. as of August 31, 2023.

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Following a challenging 2022, H1 2023 hosted a recovery among U.S. equities: the S&P 500^® (up 16.9%) posted its fourth-best first half since 1996, and there were gains across the market cap spectrum. But on a relative basis, and in contrast to longer horizons, the S&P Core U.S. Equity Indices lagged their CRSP counterparts in H1 2023 (see Exhibit 1).

The informed reader knows that 2023 has been a strong year for mega caps and Information Technology companies. Indeed, the S&P 500 Information Technology (42.8%) and S&P 500 Top 50 (27.6%) posted their best first-half performance since 1996 (see Exhibit 2). Given that S&P DJI’s indices benefited from having less exposure to Information Technology in 2022, one might expect this helped to explain relative performance in H1 2023.

Exhibit 3 demonstrates that the S&P 500’s relative performance in H1 2023 was hindered by its lower weight in Information Technology. The Brinson attribution results show that less exposure to the Information Technology sector contributed negatively to the S&P 500 (-0.6%). Combined with the negative selection effect in Information Technology (-0.6%)—the S&P 500 and the CRSP US Mega Cap Index (as represented by the Vanguard Mega Cap Index Fund as a proxy) have different constituents owing to differences in index construction—likely around 50% of the S&P 500’s underperformance was attributed to Information Technology.

The consequences of Information Technology weight were even more apparent across style indices: Exhibit 4 shows that S&P Style Indices with more (less) exposure to Information Technology out- (under-) performed their CRSP counterparts in H1 2023. For example, the S&P 500 Value and S&P 900 Value posted their best relative H1 returns over the last 10 years, beating their CRSP counterparts by 9.9% and 9.3%, respectively. Conversely, the S&P 500 Growth and S&P 900 Growth posted their worst relative H1 returns over the same period, lagging their CRSP counterparts by 15.9% and 12.6%, respectively. Various CRSP index-based ETFs are used as proxies for the CRSP indices below.

The first half of 2023 once again highlighted the importance of index construction when assessing index characteristics, given different exposures can help to explain performance differences between indices with similar sounding objectives.

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Timber is an essential resource and a genuine building block of human civilization. Its use in building construction and as a fuel source have made it integral to the functioning of our societies and world economy. On the flip side, our dependence on timber, combined with a lengthy regeneration time, means we are steadily using up this valuable resource. In the pre-industrialized world, forests covered more than 50% of habitable land.¹ Today, our growing demand for this resource has reduced this coverage to less than 40%.

Trading of timber-linked products has seen massive growth in the past decade.² This appetite for timber is expected to grow even more in the coming decade.³ Although residential demand remains the key driver for timber, other use cases like paper, packaging, plywood, etc., support demand diversity for timber.⁴

Investing in Timber

Timber is a real asset and investing in it typically involves ownership of the land on which the lumber-producing trees grow. Timber, being a physical asset, provides your typical inflation protection component, but, unlike many other real assets, has the unique feature of biological growth during times of volatility and depressed demand.⁵ The option of flexible timing of harvests during low demand can smooth out some of the price volatility of timber investments. Estimates put nearly 60% of the forestlands in the U.S. as privately owned.⁶

Capital allocation to lumber producing forestlands has traditionally been within the realm of large institutional investors that directly own the forestlands and can use intermediaries (e.g., Timberland Investment Management Organizations [TIMOs]) to manage these lands. Expertise in forestry and land management, combined with relatively long hold-up periods and illiquidity, have been leading drivers for active management of these assets. However, Timberland REITs bring the same expertise in management of timberlands and are publicly traded, providing relative liquidity, real-time pricing and transparency for these long-dated assets. Additionally, ETFs also provide another avenue of access to timber and related investments via publicly traded instruments.

The push toward sustainability as an investment goal adds another dimension to timber’s value in a diversified portfolio. Efficient water/soil/resource management, ecosystem/biodiversity preservation and positive climate impact all contribute to favorable environmental and sustainability objectives. Forests act as a carbon sequestration mechanism, and when timber from these forests is used in construction, this can further reduce GHG emissions.⁷

Indexing Approach to Timber-Related Investments

The S&P Global Timber and Forestry (GTF) Index, launched in 2007, targets exposure to timber-related investments via public equity stocks across developed market listings and local listings from three emerging market countries (Brazil, South Korea and South Africa).

S&P GTF Index constituents span the value chain of the timber ecosystem. To capture a broad investable stock group with thematic relevance, the starting universe of stocks includes firms from Timber REITS under the GICS^® classification,⁸ along with firms whose revenue comes from segments relevant to the forestry business (using the FactSet Revere Business Industry Classification System).

An exposure score framework is applied over this group of stocks to maintain the index’s thematic purity. Firms with higher exposure scores are generally seen as being closer to the core of the timber producing and processing ecosystem. Timber REITs and Timber Property Management stocks are given a higher exposure score, along with pulp mills that can be vertically integrated, when compared to Paper Mills and Packaging Products related companies that are more downstream. The index constituents’ weights are based on each stock’s exposure score and its float market capitalization, subject to appropriate constraints to avoid concentration risk.

Additionally, the index methodology excludes companies that are engaged in certain business activities (e.g., controversial weapons, tobacco products, etc.) and companies that are non-compliant with the United Nations Global Compact (UNGC) guidelines, and it screens companies for any reputational risk concerns.

As of Aug. 30, 2023, the index consists of 30 stocks, with 43% weight allocated to 11 pure-play companies, 16% weight in Timber REITs stocks and 27% weight to the companies with an exposure score of 1.

The index is tilted (56%) toward mid-cap stocks (see Exhibit 2), with the majority (over 40%) of the exposure coming from North American entities, followed by European firms (33%).

¹ https://www.visualcapitalist.com/visualizing-the-worlds-loss-of-forests-since-the-ice-age/

² https://www.worldwildlife.org/industries/timber

³ https://www.marketwatch.com/press-release/forestry-and-logging-market-2023-to-2029-projected-to-flourishing-hancock-victorian-plantations-weyerhaeuser-scottish-woodlands-tilhill-forestry-2023-06-16

⁴ https://caia.org/blog/2023/02/25/exploring-link-between-lumber-prices-and-timber-markets

⁵ https://www.ipe.com/inflation-assets-timber/37666.article

⁶ https://cdnsciencepub.com/doi/10.1139/cjfr-2021-0085

⁷ https://www.fs.usda.gov/research/treesearch/63853

⁸ For further information please see the S&P Thematic Indices Methodology.