Siobhan Cassidy | 18 March 2024
Siobhan Cassidy is a financial journalist who has worked at various newspapers in South Africa and the UK. She has also worked in a communications and marketing role in the investment management industry in Cape Town.
The JSE’s project to collapse its “vanilla” and “Swix” indices into one set of benchmark indices, underway from March 18, promises to significantly simplify South African benchmarks and possibly reduce costs for investors over time.
A widely accepted benchmark index improves comparability and transparency. This benchmark can be used to measure the performance of your active investment manager and also gives you access to index-tracking products with broad market exposure.
The JSE's vanilla indices include the FTSE/JSE All Share Index and FTSE/JSE Top 40 Index, as well as indices for the different market sectors.
There are also versions of these indices that reflect total returns – they include dividends rather than just changes in the share prices – and indices that cap the weighting of larger shares to minimise concentration risk. When the size of bigger companies is limited in a capped index, it means your investments that track or benchmark to these indices are not dominated by a few large shares and remain diversified.
For each vanilla index, there is currently also a Shareholder Weighted or Swix variant, such as the FTSE/JSE Swix All Share Index and the FTSE/JSE Swix 40 Index. The vanilla indices will from this month adopt the same methodology and therefore have the same weightings as the Swix indices, but both indices will continue for now.
“Harmonisation is a really good thing,” Kelin Pottier, Solutions Strategist at 10X Investments, says.
“Until now, every investor had to choose their benchmark from this skittle-box of SA equity benchmarks. You could go All-Share, you could go Swix, you could choose Capped Swix, Capped All-Share. You could use Top 40, Swix Top 40, Capped Swix Top 40.
“There was never a neutral representation of the local market. It also created enormous complexity in trying to assess and compare the divergent performance of different asset managers who are all using different benchmarks.”
The Swix indices were developed in response to the fact that many companies listed on the JSE are also listed on another exchange – they are dual listed.
During apartheid, companies feared losing access to the global capital markets because of sanctions. They responded by moving their primary listings to other financial centres, mostly London, and did inward listings to the JSE.
South African shares are classified as either local or foreign for exchange control purposes. This determines whether the shares that are available for trade (free float) locally or globally are used to determine their market capitalisation in local indices.
Many JSE-listed companies that moved their listings offshore persuaded the Reserve Bank to grant them a special dispensation – or grandfathering – that allowed them to be treated as local companies for exchange control purposes.
These companies still had big operations in South Africa and Regulation 28 of the Pension Funds Act at the time severely limited the amount of assets a pension fund could hold offshore. Local pension funds feared that being forced to sell their holdings in companies that had moved their primary listings abroad would prejudice investors. The Reserve Bank also feared a big flow of domestic assets offshore.
The dispensation meant the market capitalisations of a number of dual-listed shares were calculated using their full global free-float of shares, but only a small subset of these shares was held on the local exchange. This made it impossible to replicate the index using shares trading in South Africa.
Index providers responded by providing the Shareholder Weighted, or Swix, indices. These indices include companies according to the number of shares available to trade on the JSE and strip out shares held on foreign registers. This is a fairer representation of the universe shares in which local funds can invest.
In addition to the problem of shares that were listed on other exchanges, the country’s significant endowment of resources and sophisticated financial markets have resulted in some homegrown companies growing out of proportion to the market and coming to represent a disproportionately large share of it. As a result, they represent a disproportionately large proportion of indices that represent shares by their size.
“Typically, the value of listed companies is a function of the size of the local economy and their market share in it. But some companies in emerging markets make their mark on the global stage, and their prospects are no longer strictly tied to the country in which they are listed,” Pottier says.
Examples at different times would be Richemont, Anglo American and Naspers. Because they are selling into the global market, these companies generate extraordinary profits relative to other companies on the local exchange. Their market capitalisations have swelled and they tend to dominate the local index.
At its peak, for example, Naspers’ weight in the Swix reached roughly 25 percent of the index.
This presented investors and index providers with a challenge. Institutional investors cannot invest in these companies in proportion to their weight in the index as that would mean investing 20%, 25% or more of their money in a single company.
Apart from the problems with the lack of diversification and risk-management, investment mandates usually have restrictions on how much of a single stock a fund or portfolio can hold. Regulation 28 of the Pension Funds Act and collective investment scheme regulations also impose limits.
The FTSE/JSE responded by launching capped versions of the various indices, which restrict shares to a maximum weight of 10%.
The JSE in an FAQ document on the harmonisation of the indices says the Capped All Share Index and the Capped Swix were created to provide performance benchmarks that were immunised from concentration risk.
Michael Dodd, senior fund analyst at Morningstar Investment Management, says the Capped Swix has become the preferred industry benchmark for the South African equity market and “is currently used by 39% of South African General Equity funds as their stated benchmark”.
However, he adds, its adoption has not been universal, with many managers still benchmarked to the All Share and the Swix. “The different weighting and capping methodologies across these indices have resulted in some vastly different return outcomes over the years,” Dodd says.
Alignment between the All Share and the Swix has increased over the years as the number of companies considered as local due to grandfathering has declined. Corporate actions in recent years, such as moving their listing to another market, has resulted in many of these companies losing their grandfathered local status.
As a result, their weightings across the vanilla and Swix indices have converged, with only a few differences remaining. The JSE has announced that as of March 18, the remaining grandfathered shares in the vanilla indices will adopt a free float weighting methodology consistent with the Swix indices and ultimately the two indices will become one. A date for the second phase has not yet been announced as managers and investors will need the history of the two indices for some time.
Pottier says the harmonisation of the indices should result in managers who have products tracking different indices combining various funds. You should see much bigger funds, and with scale comes cost benefits that would potentially be passed on to the investor, he says.
The new JSE All Share Index will have higher allocation to shares that generate their revenues in South Africa, compared to the old index, which would mean “higher, albeit marginal, correlation between local economy and stock markets”, AlexForbes Investments deputy chief investment officer, Senzo Langa, says.
This means investors will now need to invest more assets offshore to gain higher rand hedge exposure, which is good for risk management, but not great for volumes traded on the JSE, he says.
