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SIMON BROWN: I’m chatting with Michael Dodd, senior fund analyst at Morningstar South Africa. Michael, good to chat again on the show. We’ve got the JSE index harmonisation process happening. This is effective on Monday morning [March 19, 2024].
First some history. Fund managers in South Africa used to just be all about the All Share Index. That was a benchmark. In early 2000 commodities began to dominate and that was, as I understand, when the Swix Index was born.
MICHAEL DODD: Thanks for having me on again. It’s probably worth taking a bit of a step back on the whole process, as you say. I think over time we’ve seen the preferred industry standard benchmark shift around for South African equities in particular. When I came into the industry the All Share Index was very much equity managers’ preferred equity benchmark. And, as you say, around the mid-2000s there was a strong run in resources that saw the weights of those companies increase pretty significantly in the All Share Index at that point in time, and the industry shifted away from that more concentrated resource-heavy index towards the Swix, which follows a shareholder weighting methodology and is a methodology that was deemed to be more representative of the investible universe for South African investors.
That generally worked for a while until we saw the meteoric rise of Naspers, which saw that peak in the Swix at I suppose the peak of its powers around 2017, where it was about a quarter of the index, 25%. So the same concentration risk came about in a different way, single-stock concentration risk within the Swix. In response the South African asset management industry effectively asked the JSE to launch a new capped version of that index. That happened in 2016 and their shares were capped at around 10%, and that’s generally where the preferred South African equity manager benchmark is at the moment.
SIMON BROWN: The Swix free float – free float as I understand. So for example, Anglo American holds, and I forget the number, a bunch of Kumba. That holding from Anglo American is no longer counted in the Kumba market capitalisation; I can’t buy it because it’s held by Anglo American.
MICHAEL DODD: That’s right. So I think the free-float methodology, quite simply, differs from the All Share, or what the JSE is calling its ‘vanilla indices’ versus their Swix variants. So the vanilla indices [are] things like your Top 40, being your All Share index. And then you have for all of those JSE benchmarks or JSE indices a Swix variant of those particular indexes, and the Swix versions effectively use a free-float waiting methodology. So that basically takes the register on straight. So basically the shares that are available to South African investors and aren’t; it adjusts for things like Anglo’s holding in Kumba and where other listed entities are holders of other entities, but also adjusts for foreign shareholder listings.
So something like Anglo American is also listed as a primary listing on the London Stock Exchange. It’ll have foreign shareholders. That counts in terms of a market capitalisation perspective in the weighting of the All Share index, but won’t count for the Swix, which basically looks at the South African shareholder register.
SIMON BROWN: Gotcha. So a fair representation of the availability in the market. What were ‘grandfathered’ stocks? I remember a conversation around this a decade or more ago, but I can’t remember what grandfathered stocks were actually, how they fitted into the index process.
MICHAEL DODD: A grandfathered company or ‘grandfathering’ refers to companies that are local companies but moved their primary listing offshore before October 2011. Those are the companies that are weighted differently in the vanilla indices versus the Swix indices.
I think over time the number of grandfathered companies in those indices has declined because, as you’ve seen corporate actions take place, the weightings have adjusted towards the Swix methodologies. Examples of some of those include corporate actions – the likes of SAB Miller a long time ago, the likes of Old Mutual, where they moved their primary listing back to South Africa through the managed separation process, [and] the BHP group. And, most recently, what we saw last year was Richemont.
So the number of those particularly big grandfathered companies has generally been in decline over time.
As we’ve now only a handful of these remaining grandfathered companies that are constituents of the JSE indices, the JSE sees now as probably the most opportune time for them to align the weighting methodologies of the vanilla indices and the Swix indices without too much disruption. That’s what the Index Harmonisation Project effectively does.
SIMON BROWN: And the All Share becomes the Swix methodology. Changing an index is risky. You make the point that this is a good time to do it. Are we going to see big changes to any of the weightings?
MICHAEL DODD: There will be [changes], and the ones that are most affected will be those grandfathered shares. So maybe at a pure index level, and if you’re looking at the Swix indices, there are no changes. But for the vanilla indices – your Top 40s, your All Shares –, there will be some change. At a single stock level, the biggest index constituents that are affected are Anglo American and Mondi, and their index weights in the Top 40, the All Share index, those vanilla indices adjust downwards at the rebalance.
And then if you look at sort of a sector level, it means because of the nature of those companies we’re going to see declines in the resources components, in particular, because that’s where Anglo-American is a big part of the index. So you’ll see the materials and industrial sectors – which are the homes of Anglo American and Mondi – drop in weight, and all the other non-affected companies in those indices effectively get commensurately up-weighted. The biggest beneficiaries will probably be the financial sector and our banks.
And as a result, another by-product of the change is because these grandfathered shares are your foreign-listed companies. This means there’ll be a shift in, I guess, the index composition of the vanilla indices, where the foreign component falls and the local component of the indices will increase. So you’ll be getting marginally more South Africa exposure from your local market index.
SIMON BROWN: A quick point for the listeners: the index values won’t change. They manage that internally, so you’re not going to suddenly see an index jump. But to your mind, and to that of Morningstar South Africa, my sense is this is a good idea. You concur [with me] that the JSE has managed it well. You said they’ve used an opportune time to do it and it kind of gives us a single benchmark that we can convalesce around.
MICHAEL DODD: Yes, we agree with that. We think it’s a good thing for the industry. And we think it’s important for several reasons, because if you end up with a single representative benchmark index for the South African market, that’s a good thing and it removes a lot of end-investor confusion. Even when comparing the performances of South African equity managers, where there is no universally agreed-upon industry-standard benchmark, a lot of people are still benchmarked to the Alsi and the Swix and the Capped Swix. If you get that, it makes comparability a lot better.
We think it’s important for several reasons, the first being uniformity. Having a single equity index reduces the confusion among investors regarding equity-market performance and should hopefully result in an alignment of benchmark selection for South African equity managers.
Secondly, what that does is it improves the comparability of performance. So having a standard industry benchmark where everyone’s managing to the same benchmark means that your outperformance or underperformance relative to peers can no longer be explained away by benchmarking differences.
There is still some, I think, cleanup that’s required at maybe an Asisa [Association for Savings and Investment South Africa] fund category level, particularly for the South African equity general category, where you have some managers that are domestic only, and others that are making full use of the offshore allowance that the category permits. Those two aren’t exactly comparable, and that does lead to a challenge. But at least the index harmonisation does address the benchmarking issue.
And then lastly we think, just for the benefit of the end investor, with a standard industry benchmark comes a universally agreed-upon proxy for market beta. If you’re looking at the range of index-tracking products that are out there and being offered on all of these different JSE indices, you will probably start to see some cleanup. We’ve already started to see that from some of the service providers who closed or merged products that effectively become duplications of others at the end of this project.
That effectively provides the opportunity for product providers to improve their economies of scale by sort of bulking the assets that were in different index products into one. That potentially opens the door for them to lower fees to end investors where they are getting better economies of scale – which we think can only be a good thing for the end investor.
SIMON BROWN: I take your point. All round good news. We’ll leave it there. Michael Dodd, senior fund analyst at Morningstar South Africa, I appreciate the time.
