S&P’s New Dividend Indices: Really alpha or just alternative beta?

Risk Management 30 Jan 2008

While we’re on the topic of indices containing alpha (see Tuesday’s posting), check out this “alpha producing” index launched last Friday by S&P.   

In a move sure to sow confusion among passive investors, S&P says it’s new “Dividend Opportunities Index” (index methodology).  In a press release announcing the launch, Tim Eisenhauer, VP of Standard & Poor’s Index Services says:

“The launch of these two indices underscores Standard & Poor’s commitment to producing alpha generating strategy indices with a methodology designed to provide returns over and above traditional benchmark indices…”

As first blush, these indices seem to produce something pretty special.   But is it alpha?  Here is a chart from the fact sheet:


Notwithstanding the arguments in favour of a new paradigm of active indexing (see related posting on 130/30 indices), our jury remains out on whether a passive strategy can produce alpha.  To be sure, a passive index could certainly out perform a benchmark, but that doesn’t mean it produces alpha (in fact, it probably does not).  For example, a levered benchmark position would outperform in rising markets.  Or an index of options could out perform assuming volatility behaves a certain way (e.g. a short-volatility portfolio in a low-vol market).  In both these cases, investors would likely eventually pay the piper for what looked to be alpha over a shorter time period.

The short-vol. example above is just one instance of alternative beta.  Another might be the return generated by high yielding dividend stocks.  According to S&P:

“Both the S&P Global Dividend Opportunities Index and the S&P International Dividend Opportunities Index are comprised of 100 tradable, exchange-listed common stocks from across the world that offers high dividend yields.”

If only alpha production were so easy.  Still, according to the fact sheet from S&P, the indices have a 5 year Sharpe ratio in the 0.5 range (ret: 26.4%, sd: 11.0%), vs. 0.3 for the S&P 500 itself (ret: 12.8%, sd: 8.6%).  But this could simply be a result of a number of factors such as the nature of dividend paying stocks themselves. 

We’re not saying this index will pay the piper any time soon.  In fact, this strategy may continue to work for the foreseeable future.  But the annals of financial history are littered with stories of “alpha producing” strategies that seemed to magically out perform in the short run, only to revert to the mean over the longer term.  True alpha, like art, is impossible to replicate.  Anything else is alternative beta.

You can follow the alpha-producing progress of these indices at home.  Bloomberg added one of the indices 2 weeks ago.

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