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Providing TRU-ly Targeted Equity Exposure

Dec. 11, 2015

Dec. 11, 2015

The problem: Geographical overlaps

Traditional equity indices are constructed by selecting companies on the basis of their country of domicile and/or primary listing. However, many companies generate revenue in numerous locations, not just their home markets. By investing in the S&P 500 Index, for example, investors gain exposure to the US economy, but also to the international markets in which its constituents generate revenue. These international interdependencies can lead to unintended risks for investors.

The solution: STOXX TRU™

The STOXX True Exposure™ Indices (STOXX TRU™), can offer a solution to this problem. The indices are constructed by not only taking into account a company’s country of incorporation but also its regional source of revenue generation. This allows investors to achieve a significantly more distilled focus on targeted markets or regions. STOXX TRU USA indices, to name an example, select US-domiciled companies with varying degrees of revenue exposure to the United States. The indices are available in four versions, with varying levels of US-market focus, ranging from a minimum revenue exposure of 25% to a maximum exposure of 100%. This ultimately gives investors a choice of sharper, targeted exposures.

The immunization effect

As mentioned, the (uncontrolled) revenue exposure of companies selected into standard equity indices to markets outside of the targeted region can have a significant impact on the index’s performance. For example, performance can be negatively affected by foreign crises. Compared with standard equity indices, STOXX TRU Indices reduce investors’ exposure to foreign markets by having greater focus on the targeted region. Consequently, STOXX TRU Indices are found to be more immune to such foreign crises.

Example: The recent China crisis

So what was the influence of this year’s drop in Chinese markets on US equities?
We analyzed the performance of the STOXX TRU USA Indices relative to that of the S&P 500 index, covering the period in which Chinese shares experienced the first of their steep falls (between Jun. 23 and Jul. 8), following a strong year-long rally.
Over the period to Jul. 8, US equities, as represented by the S&P 500 index (with 3.48% Chinese exposure according to STOXX calculations), displayed a maximum drawdown of 3.55% . However, the STOXX TRU USA Indices, where exposure to China was smaller, drew down by less. The STOXX TRU USA 25% (with 1.98% China exposure) showed a maximum drawdown of 3.25% over the period. Both the STOXX TRU USA 50% (with 1.27% Chinese exposure) and the STOXX TRU USA 75% (with 0.43% Chinese exposure) indices held up better, with maximum drawdowns of 3.05% and 2.72%, respectively. For the  STOXX TRU USA 100% (with 0.02% China exposure) the maximum drawdown was just 2.35%. In summary, the smaller the exposure to China, the smaller the reaction to the crisis. The chart below illustrates these results. The top line represents the STOXX TRU USA 100%, which performed best over the period, while the bottom line shows the S&P 500, the index with the highest exposure to China, which declined the most.

graph

1)    Performance is measured in USD gross return.
2)    Drawdown values reference the time period [23 June, 2015 to July 08, 2015]. Index returns are measured in USD gross return.
3)    The S&P 500 composition is based on the composition of the respective iShares ETF.
4)    Revenue exposures of the US S&P 500, STOXX TRU USA 25%, STOXX TRU USA 50%, STOXX TRU USA 75% as well as of STOXX TRU USA 100% are weighted according to free-float market cap.

Please share your feedback, comments or questions by sending an email to our editors at pulse@stoxx.com.

 

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