Indexing Developments

March 01, 2006

It's Official: S&P's New Style Indexes Go Live

S&P finalized the transition to its new generation of style indexes on December 19, casting off the old S&P/Barra indexes in favor of the new S&P / Citigroup benchmarks. The new indexes use a more complicated methodology to divide stocks into the two style camps of growth and value: Whereas the old indexes looked only at the price/book ratio, the new indexes use seven variables.

"The new S&P Style Indices are the next generation in style indexing, offering investors a multiple factor definition of style," says David Blitzer, managing director and chairman of the Index Committee at Standard & Poor's.

S&P is offering two sets of style indexes: The "Style" index series offers a traditional breakdown of the entire market into the classic growth and value segments, while the "Pure Style" index series excludes companies that exhibit neither strong growth nor strong value characteristics. To further accentuate the "Pure Style" indexes, S&P applies a "style weighting" methodology, assigning the highest weights to companies with the strongest style score s .

Barclays Global Investors (BGI) has a l ready transitioned its existing style funds to the new "Style" indexes , while Rydex has announced plans for a series of "Pure Style" ETFs.

S&P To Expense Options

Standard and Poor's said it would begin to include options-related expenses when it calculates earnings for the S&P indexes in 2006. The move cut forecast earnings for S&P 500 companies in 2006 to $64.87, down 7.3 percent from $69.62.

The change comes as a new Financial Accounting Standards Board (FASB) rule takes effect requiring all companies to expense their options.

"The ability to compare costs across company and sector levels is vital to the investing community," says Howard Silverblatt, Market Equity Analyst at Standard & Poor's. The sector most exposed to the accounting change is Information Technology, which would have lost more than 19 percent of its "as reported" earning for FY2005 under the new system. Many companies, however, accelerated options vesting in 2005 to avoid the hit to earnings in 2006.

Amazon.com Enters The S&P 500?!?

Amazon.com replaced AT&T in the venerable S&P 500 Index on November 19, as Ma Bell was swallowed up by SBC Communications. Five years ago, the media would have gone crazy covering the swap, and hailing the coming of a new age. In 2005, it passed with barely a peep.

High - Yield Aristocrats

State Street Global Advisors (SSgA ) rolled out an ETF in December tied to the new S&P High Yield Dividend Aristocrat Index, which selects the 50 highest-yielding stocks in the S&P 1500 with a 25-year history of boosting their dividends. The new fund will go head-to-head with the $7 billion iShares dividend ETF (DVY) and the $500 million dividend fund fro m PowerShares (PEY).

"Unlike most dividend-oriented portfolios, the S&P High Yield Dividend Aristocrats Index is broadly diversified across sectors," S&P argued in its press release announcing the new index.

That's kind of true. The new S&P index has 47 percent of its exposure tied to Financials and Utilities, compared to 59 percent for the index tracked by the iShares fund and nearly 80 percent for the index tracked by the PowerShares offering. But still, 47 percent is no small potatoes.

According to S&P, the High Yield index has posted higher risk-adjusted returns than the S&P 500, S&P 500 Equal-Weight Index and "other comparable indexes" over the past five years. S&P also says that the index's components have "higher returns on equity, higher quality ranks and higher credit ratings" than the holdings of competing dividend indexes.

Dividend Party Goes Global

Sensing the growing interest in dividend-focused portfolios, Dow Jones launched two new indexes on December 5 designed to track the performance of dividends creened portfolios in international markets. The new Dow Jones Select EPAC Dividend Index tracks the 100 top dividend-heavy companies in Europe, Asia, Australia and Canada, while the Dow Jones Select Canada Dividend Index focuses solely on the U.S.'s great neighbor to the north.

The new EPAC index uses a double-dividend weighting system, first weighting countries by dividend yield and then weighting individual companies within each country by yield. That translates into a gaudy 4.4 percent yield for the fund, which posted returns in excess of 30 percent in 2004.

The Canadian index includes 30 of the top dividend paying stocks in the Canadian market, and offers an interesting blend of exposure to banking and natural-resource stocks.

All Or Nothing

Dow Jones Wilshire rolled out new U.S. industry-level indexes based on the Dow Jones Wilshire 5000, giving DJ/Wilshire a full suite of U.S. sector indexes for the first time in its history. The indexes are based on the Industry Classification Benchmark, or ICB, a (relatively) new classification system developed jointly by Dow Jones and FTSE.

Building Your Future, BRIC By BRIC

Investors looking to ride the wave of globalization to financial success soon can start building their portfolios BRIC by BRIC. That's BRIC as in Brazil, Russia, India and China ... the four horseman of the developing economy. These four countries have been the hottest economies in the world for the past five years, and many pundits are calling for that trend to continue. MSCI launched a new index on December 6 tracking these powerful emerging economies, and the company suggests that index funds and ETFs are on the way. MSCI also rolled out value and growth BRIC indexes.

Malaysia Wants In On Game

FTSE and Bursa Malaysia, the Malaysian stock exchange, joined forces in January to launch a new suite of indexes covering the Malaysian domestic markets. The indexes will be investable, and are being created with the explicit goal of supporting ETFs and other index-linked investment products.

"The creation of these new indices will result in us having more internationally aligned benchmarks for our market," says Yusli Mohamed Yusoff, the chief executive officer of Bursa Malaysia. "This enables investors to better assess our market's competitiveness at the global level."

Both FTSE and the Bursa Malaysia believe that the new indexes will "attract both domestic and international investors with an interest in Malaysian stocks," according to their joint press release

The Malaysia deal comes six months after FTSE inked a similar agreement with ASEAN, the southeast Asia regional trade group, to launch a series of indexes tracking the performance of ASEAN market countries (which include Malaysia).

Taking Us To A Bull Market

The old and somewhat forgotten Dow Jones Transportation Index (the "Transports") surged to a new intra-day high on November 18, touching 4,133.78. The index has more than doubled in the past two years, riding a strong performance from its four railroad components.

A new high in the "Transports" may not seem like a big deal to most people, but to followers of Dow Theory, it speaks volumes. Dow Theory was a market theory created by Charles Dow himself. Basically, it says that any time the Dow Jones Industrial Average (DJIA) and the Transports move to new highs together, that spells the start of a long bull market. The recent move in the Transportation Index has the Dow theorists excited because the Transports are usually the first index to break out-the DJIA typically follows along some weeks or months later.

Of Pensions And Hedge Funds

A new bill passed by the House of Representatives would loosen restrictions on the ability of pension plans to invest in top hedge funds, potentially shifting huge sums of money toward the hedge fund industry. Currently, hedge funds must derive no more than 25 percent of their assets from pension plans, or else they fall under the myriad legal requirements of the Employee Retirement Income Security Act (ERISA). Most top funds would rather not be bothered, so they cap their exposure at 25 percent. The new law would up that number to 50 percent, effectively doubling the amount of money that the top hedge funds can pull in. The bill still must be reconciled in committee.

The Long And The Short Of Hedge Fund Returns

The results are in for the hedge-fund industry for 2005, and they aren't pretty. While different hedge fund indexes posted different returns (they hold wildly different funds), almost all of them lagged the broader global markets.

The Standard and Poor's Hedge Fund Index did the worst, rising just 2.28 percent for the year. The Hennessee Hedge Fund Index did better, rising 6 percent, while the popular CSFB/Tremont Investable Hedge Fund split the difference, rising 3.48 percent. The Greenwich -Van Global Hedge Fund Index posted the highest returns of any weighted hedge fund, possibly thanks to its global bent, returning 8.3 percent.

While most of the indexes outstripped the 3 percent return of the S&P 500, that's not a fair comparison, since most hedge funds aren't limited to domestic investments. A better comparison would be a global benchmark like the S&P Global 1200 or the MSCI World Index: Those indexes rose 7.6 percent and 9.5 percent, respectively, leaving most hedge funds in the dust.

It doesn't get much better if you drill down to the specific strategy level. None of the six strategies tracked by the Dow Jones Hedge Fund Indexes matched global market returns.

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