This article is sponsored by S&P Dow Jones Indices.
Risk is a complicated thing, and S&P Dow Jones Indices’ experience supporting the VIX® series of volatility measures, its continued work in the arena of low-volatility indices and its conversations with clients regarding risk reduction techniques continue to reveal new things about the way markets and investors can react to – and even control – volatility.
But market volatility is not all there is to it. Which is why S&PDJI recently inaugurated commentary on equity market “dispersion”, a market-wide measure of security-specific risk that can be useful in identifying markets and time periods where there is greater opportunity to add value through security selection.
That risk can be indistinguishable from opportunity is a concept as old as the hills, but it is one that is rarely studied. It turns out that including dispersion as well as volatility in the analysis can have surprising results, particularly when applied to common equity factors such as value, or momentum. SPDJI is pleased to include its latest thinking on the topic in “The Landscape of Risk]”.
J.P. Morgan famously remarked, when asked what the stock market would do, that “it will fluctuate.” It was a safe prediction. No matter how we regulate or manage our markets, volatility frequently roiles them. From a classical point of view, high volatility presents opportunities – the prime example being the predictable increases in both risk and return that result from the application of leverage. Thus by implication in the typical legal disclaimer, an increased opportunity for return is associated with increased risk.
Yet periods accompanying extreme fluctuations in the equity market are more often than not associated with losses. In Section 1, “The Landscape of Risk” examines the negative correlations that emerge between market prices and volatilities of the U.S. equity market. Two themes emerge – first, that market behaviour is fundamentally different during periods of high volatility, and second, that opportunities, if they are present, might be comprehended as simply the chance to purchase equities at a discount.
In Sections 2 and 3, the paper examines the structural composition of market risk via the relationship between the volatilities of individual securities and market benchmarks, and relate each to the other with approximating equations. These equations describe a three-dimensional surface, a “landscape of risk,” which is compared to historical market behavior in Section 4.
Not all crises are the same. Although each major pullback in U.S. equities during the past decade has been characterized by unusually high correlations, the bear markets of the early 2000s were instead accompanied by a large degree of independence among the stocks of different sectors. The results of Section 4 describe the role of correlations in crisis periods and describe the potential evolutions of volatility and stock-to-stock correlation that might accompany the next one.
A second goal of this paper is framed by the notion of seeking opportunity in crisis. This theme emerges in Section 1 in the context of market performance, and in Section 2 is a discussion of the subtleties that arise in applying the same concepts to single securities. In Section 3, the paper introduces the concept of dispersion in order to address these subtleties. In Section 5, the paper attempts to attribute the historical relative performance of equal weight, growth, value, and momentum strategies to changes in U.S. equity dispersion. Finally, in Section 6, the current environment is described.
S&P Dow Jones Indices’ “The Landscape of Risk” white paper can be downloaded here. The Landscape of Risk.
How Do Public Pension Funds Invest?
This article is sponsored by State Street.
Public Pension Funds (PPFs) are highly idiosyncratic and distinct from other types of institutional investors. The universe of investors that fall within our definition of a PPF is numerous and varied. We count 115 institutions in 70 jurisdictions, diverse in geography and economic development. For the purposes of our study, we examined the top 16 funds whose assets constitute just over two-thirds of the total universe. Despite all the idiosyncrasies of PPFs, we have found some shared characteristics in the evolution of their asset allocation over the past decade.
According to our definition, PPFs held around $5.9 trillion in total assets of 2016 and over 4% of all publicly traded assets, making them a significant global investor group. In particular, given their preferences for specific asset classes, their share is disproportionate in some segments. For example, we estimate that by year-end 2016, PPFs owned over 7% of global tradeable fixed income assets (including 8% government bonds and over 13% of inflation-linked bonds) and over 3% of listed public equities.
Similar to other asset owners, PPFs have undertaken a major reallocation of assets over the past decade. However, the motivating driver has not only been the low yield environment, but also changing regulatory and macro policy settings, which either permitted or encouraged greater diversification along asset classes and geographical exposure.
In detail, the most dominant trend has been the move away from holding domestic (local currency) bonds; in their place, PPFs have redeployed assets towards equities and alternatives, with a small share also diverted into foreign bonds. These allocation trends have been almost universal despite a huge diversity of geography and economic development.
It is important to acknowledge how much this investor group has changed over the past decade, with the asset pool growing by over 40% in dollar terms, and even more if measured in local currencies. While some funds are still predominantly captive buyers of government debt, the bulk of PPFs have been transforming into financial institutions with independent firepower and income-generating capacity. The long-term trend towards more diversified fixed income portfolios is likely to continue, as is the shift towards taking on more risk via equity allocations, subject as ever to changes in market cycles. In this context, we expect most PPFs to not only continue taking on more risk overall, but to further internationalise their portfolios.
Finally, one consideration is that maturing funds catering for aging populations will have to make further adjustments to their asset allocations to account for changing cash flow directions and seek greater contributions and investment returns to bridge any funding gaps.
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
This document may contain certain statements deemed to be forward-looking statements. All statements, other than historical facts, contained within this document that address activities, events or developments that SSGA expects, believes or anticipates will or may occur in the future are forward-looking statements. Please note that any such statements are not guarantees of any future performance and that actual results or developments may differ materially from those projected in the forward-looking statements.
Tracking Code: 2172159.1.1.GBL.RTL
By clicking on the link to view the report, you acknowledge you are an institutional investor or other accredited investor.
Elliot Hentov, Ph.D. Head of Policy and Research, Official Institutions Group Elliot_Hentov@ssga.com
Alexander Petrov Policy and Research, Official Institutions Group Alexander_Petrov@ssga.com
Sejal Odedra Business Analyst, Client Strategy, Official Institutions Group Sejal_Odedra@ssga.com
The Slings and Arrows of Passive Fortune
This article is sponsored by S&P DJI.
If a tale were to be written regaling us with the popular exploits of the modern day active manager in his quest for alpha across the many peaks and valleys of the financial world, passive investment would likely feature prominently in the telling. Passively managed assets have grown tremendously since their introduction in the 1970s to command some 20% of the U.S. stock’s market total-float adjusted capitalization, drawing a deluge of criticism in recent years from proponents of a more traditional, active approach who charge indexers with all manner of supposed ills – from encouraging collusive behavior and exacerbating pricing inefficiencies, to indifference on matters of corporate governance.
But are passive assets and their purveyors really the threat to markets that active management makes them out to be? Or are the problems attributed to their rise merely a reflection of the market forces all participants must face? These are the questions posed by Anu Ganti and Craig Lazzara at S&P Dow Jones Indices (S&P DJI) in their new paper, titled “The Slings and Arrows of Passive Fortune,” which seeks to unravel some of the most pervasive myths surrounding the growing role of index funds, highlight the immense value they bring to asset owners, and posits a future of asymmetric equilibrium between the old and the new that puts each in their proper place based on relative – rather than absolute – performance.
Nobody – including the paper’s authors – denies that index-based investment has made life more challenging for active managers, who count alpha as their very lifeblood; but so too would it be foolish to argue its advancement as one of the most important developments in modern financial history is without merit, or somehow Thucydidean in nature. If anything, active management can and should expect its portion of the pie (which, it must be pointed out, constitutes the majority of assets by a wide margin) to remain subject to nibbles from their passive counterparts – nibbles that may, with time, diminish. The market always has room for more players at the table, after all, and we all play by its rules.
As Director and Managing Director of index investment strategy team at S&P DJI, Ganti and Lazzara provide research and commentary on the firm’s entire product set – covering U.S. and global equities, commodities, fixed income, and economic indices. Both are chartered financial analysts and regular contributors to Indexology, S&P DJI’s appropriately named blog covering developments in the world of indexing.
Battea: 2017 Securities Class Action Industry Lookback and Observations
This article is sponsored by Battea.
There has been incredible growth in securities and antitrust class action litigations and settlements, particularly as they have unfolded in 2016 and 2017. The number of new cases and settlements from traditional securities litigation to antitrust rate rigging, spread inflation and other forms of collusion are at an all time high and shows no signs of slowing down.
With several multi-billion dollar litigations related to Libor, Euribor and Tibor rates, and spread manipulations, the securities, foreign exchange and antitrust class and collective actions litigation space rose exponentially in 2017.
View Whitepaper Here
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