Culling the index herd on the JSE

What the Johannesburg Stock Exchange (JSE) calls the ‘Harmonisation Market Proposal’ will reduce the number of confusing indices tracking the performance of the market and market sectors. This harmonising simply means the JSE will use the same method to calculate different indices.

Aligning the way in which the exchange calculates its shareholder weighted indices (SWIX) and the traditional indices will, for example, result in the financial index and the SWIX financial index being exactly the same. One is enough, with the result that all 63 SWIX indices will disappear as their 63 existing counterparts will take over their role.

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The JSE notes that in a few instances, the indices are already identical or very similar.

It said in an announcement in September 2022 that the project to harmonise the methodology of index calculation will ensure that the indices are aligned with evolving market requirements and continue to be relevant in the future.

“The purpose of index harmonisation is two-fold,” it said. “The first is to have one broad-based market capitalisation weighted index methodology that treats all companies consistently and appropriately, particularly with regards to the calculation of free float.

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“The second is to reduce the number of closely similar or overlapping indices in the series and, if necessary, to introduce new specialist and differentiated indices that are aligned with market demand.

“This proposal means that from March 2024, FTSE/JSE will no longer offer any indices with a SWIX label, and all benchmark indices will use the historic SWIX weighting methodology,” according to the JSE, with their long technical explanation saying that the crux of the matter is the way in which it calculates the number of shares available to investors (the free float).

The so-called vanilla indices will switch to the SWIX methodology to determine free float and index weight.

All indices that currently have two variants, a vanilla and SWIX, will harmonise into a single variant that retains the vanilla index code and name, but will use the SWIX calculation methodology.

History

The different indices and the different formulas to calculate them came about when the JSE struck an agreement with the London Stock Exchange (LSE) in 2001 to expand cross-dealing between the two bourses.

The JSE switched to the LSE’s trading system and also adopted the same market sector classification.

The JSE launched the SWIX series of indices in 2004 with the difference being the treatment of the free float of shares. The SWIX methodology introduced a free float calculation based on the minimum between the portion of shares held on the local SA register and the free float calculated using publicly available information such as annual reports.

Part of the launch of SWIX indices was that SA investors suddenly got a lot of new indices.

The JSE lists no fewer than 169 indices in an addendum (published last week) to the announcement about the newest changes.

This is a far cry from the single original index measuring the performance of the JSE, developed and calculated (by hand in the early years) by the Rand Daily Mail newspaper.

The need for harmonisation

The harmonisation project became necessary due to earlier treatment of large international companies including some of the biggest companies on the JSE, such as British American Tobacco, Anheuser Busch, Richemont and Prosus.

“Inward Foreign Listings (IFL) were not eligible for FTSE/JSE index inclusion. This was because a trade in such a company counted toward an investor’s foreign portfolio allowance in South Africa. After October 2011, all Inward Listed equities on the JSE traded and settled in rands were reclassified as domestic for the purpose of trading on the JSE and its indices.

“Although these IFL’s were now eligible for inclusion to the FTSE/JSE indices, they were only included on the condition that their index free float could not exceed the proportion of their shares held on the South African share register. In other words, they were eligible for inclusion to the vanilla indices, but only using their SWIX free float.

“When this Inward Listing rule was introduced in 2011, it was agreed that a small number of companies that were already index constituents would be ‘grandfathered’ and excluded from the treatment.

“Therefore some, seemingly, foreign companies are not deemed as Inward Listings on the JSE for the purposes of free float determination,” says the JSE.

“Examples of these included Anglo American, BHP Billiton, Reinet, Mondi and Richemont. These companies, even after 2011, continued to be treated as local for all index purposes, and therefore [have] a different free float in the vanilla indices compared to the SWIX indices,” it adds.

Other indices

The JSE admits in its documents that there is too much complication with too many indices, and a lot of (unnecessary) work.

“A final challenge is around complexity of messaging,” it says.

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“To maintain two parallel sets of indices (including the All Share, Top 40 and sector indices) that have such similar weightings and methodology creates unnecessary complexity in index selection and provides almost no meaningful diversification between the two indices in return. This fragments liquidity, and introduces unnecessary complexity in benchmark selection and analysis.”

Why not cull more?

That a lot of the indices will disappear raises more questions, along the lines of whether they were relevant to start off with and whether some other indices can be culled as well.

For instance, the JSE calculates several indices under the working agreement with the LSE that look irrelevant, given that some of the sectors on the JSE have a total of one listing.

The beverage sector only has a single listing, AB InBev, meaning that the index will only track its performance.

The same goes for personal goods (Richemont) and tobacco (British American Tobacco).

There are a few sectors with only one small company – each with its own sector index. The automobiles and parts sector has one listing, Metair, with a market capitalisation of only R3 billion. The leisure goods index tracks only Nu-World (market capitalisation of a mere R554 million). Mustek is the sole listing in its sector and sole constituent of the technology hardware and equipment index. It has a market capitalisation of only R47 million, of which barely 80% in available as free float.

Several other sectors have only a handful of stocks, but the market capitalisation and relevant index are dominated by one or two big companies.

None of these indices will be used as a benchmark for any investment fund, nor the basis of a tradeable index on a market for derivatives.

Yes, calculating indices for sectors on the LSE with its nearly 2 000 listed companies is different from applying the same standards on the JSE with only 305 companies – some of which are in the process of delisting.

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