For individuals wishing to buy an index fund that tracks a South African market index, it is important to understand what exposures you are buying and understand how these indices are calculated? Corion Capital helps you answer these questions.

A stock market index is a basket of stocks which represents a segment of the financial market. These segments could represent geographies, sectors, market segments, themes, or strategies. The basket composition may change periodically according to predefined rules or corporate events and are determined by the index provider.

The FTSE/JSE ALSI, Capped ALSI, SWIX, and Capped SWIX are broad stock market indices that include some of the most significant South African stocks and are therefore considered to be good representations of the overall South African stock market. It is important to note those indices that get the largest coverage in the press may not always be the most relevant for an investor’s needs. When choosing an equity market index, it is important to understand the composition of the index you are buying and how it is priced.

Pricing of indices are a market capitalisation weighted average of each stock in the index basket, where weights are free-float adjusted (to represent shares available to trade on stock exchanges globally) for the ALSI indices, or further adjusted to be shareholder-weighted (to represent shares on the South African shareholder register) for the SWIX indices.

A disadvantage of the ALSI and SWIX is they both contain stocks with very large weights (see total weight of top 5 stocks in the table below). To mitigate stock concentration risk and improve diversification, the FTSE/JSE provide capped versions of these indices where the maximum weight of a stock in the basket is not more than 10% of the total basket.

The table below summarises the key features of these South African equity market indices.

Though each of these indices are used as a gauge of the strength of the South African stock market, they have had meaningful deviations in performances over the last 10 years, but even more significant deviations over the shorter term. This is due to differences in industry exposures (noted in the second table below). The chart below illustrates the annualised performances of the indices over different time windows.

So, what do you get when you buy these indices? The chart below summarises the industry exposures of each index. It is important to understand the industry breakdown in order to assess if it meets your investment objectives.

The largest index exposure deviations are in Materials, Consumer Discretionary and Financials.

If your objective is to gain broad exposure to the South African equity market and replicate the performance of the market itself, you can stick to investing in the broader market indices like the ALSI and SWIX. However, if you are concerned about stock concentration in your basket of stocks and want more diversification of stocks, using the capped index options are more appropriate.