A financial index is a basket of securities, physical assets or other financial instruments that provides a measure of performance of a market, an asset class, a sector, or an investment strategy.
Over time, certain indices have come to represent much more than what’s happening in the market: they give a snapshot of the economy and investors’ mood in general and inform policymaking and other key financial measures such as interest rates.
The measure provided is a numeric score that can easily be used to track and compare the performance of a group of assets over time or against others in a standardised way.
Investors cannot invest directly in an index, but they can invest in a fund or portfolio that tracks or replicates the components of an index.
When people say the market moved up or down they are referring to the movement of an index. Analysts often, for example, use the JSE All Share Index (ALSI) or the JSE Top40 Index as a proxy for the JSE.
The JSE’s main index, the ALSI, consists of roughly the largest 99% of companies listed on the main board of the JSE as measured by market capitalisation. Also sometimes referred to as the FTSE/JSE All Share index, the ALSI is maintained by the Financial Times Stock Exchange group (FTSE or Footsie), the British provider of stock market indices that now trades as FTSE Russell.
Indices have long been used as benchmarks and measures of aggregate performance. They have become increasingly well-known outside of the investment world as index tracking, or passive investing, has become mainstream.
Index investing is a low-cost way to replicate the returns of popular indices. It is also often referred to as passive investing. Index-tracking funds invest in shares that make up an index, buying a representative slice of that basket of securities. They aim to track the performance of the index as closely as possible. An index investor is said to be “buying the market” that the index represents.
Indices are also a valuable tool for the managers of, and investors in, actively managed funds or portfolios, as they provide the benchmark against which these investments are measured. This comparison is key to understanding a portfolio's performance. Read more: What is active investing? and How should I check the performance of a unit trust fund?
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The DJIA, introduced in May 1896, was not the first Dow index created by Dow Jones & Company, set up by journalists Charles Dow and Edward Jones in 1882. The first index, created in 1884, the Dow Jones Railroad Average, consisted of 11 stocks, including the New York Central and Union Pacific, and two non-rail stocks, Pacific Mail Steamship and Western Union. It was published in the Customer's Afternoon Letter, a daily financial news bulletin which was the precursor to The Wall Street Journal. The first iteration of the DJIA comprised 12 industrial sector shares selected to represent major areas of the US economy following the recession in the late 1800s. Today, in addition to providing information on what happened in the US stock market, the closing level of the Dow gives an outlook for the US economy. |
Broad-based indices, such as the Dow Jones Industrial Average (DJIA or just ‘the Dow’), FTSE All Share, S&P500 or the JSE’s ALSI, are a measure of the entire market in specific countries. There are also a number of global indices, numerous regional indices and a multitude of specialised indices, tracking sectors, segments and themes, such as oil and gas, renewables and clean energy.
There are millions of indices around the world, and the number continues to increase in line with the growing appetite for new ways to invest in markets using index-linked investment products, such as exchange traded funds (ETFs). Read more: What is an ETF?
Theoretically, if you buy the main market index, such as the JSE’s ALSI, it represents the domestic equity market. But not all the shares in the market are available for shareholders to trade for two main reasons:
The All Share SWIX free float, for example, represented the investable domestic equity market – the proportion of listed companies’ share capital that is registered on the South African share register.
The JSE has decided that from March 2024, SWIX index series will cease to exist and the methodology will be adopted by the “main” index series.
This means that, after the March quarterly review, the ALSI and the Top40 (and all the other main indices) will be based on the current SWIX free float, rather than the current overall free float.
Because buying a portfolio of shares that fully represents the ALSI is not very cost effective, especially for a smaller investor, the JSE introduced the so-called tradable indices, such as the JSE Top40 Index.
The index of the 40 largest companies listed on the JSE by investable market capitalisation is the index many people monitor as an overall benchmark for the local exchange. Companies included in the Top40 are generally larger companies with widely traded and marketable shares. This is a relatively small portion of the total number of securities on the JSE but movements in the share prices of these key companies are seen to represent the movement of the market as a whole.
A capped index is an equity index where an upper limit is set on the weight of any one security. A maximum percentage is set on the weighting of a single component even if that company carries a bigger weight in the market owing to its size. This is particularly relevant in South Africa, where the stock market and, therefore, the main indices tend to be dominated by a few, very large players.
Putting a cap on any single stock reduces the risk of an outsized negative impact on an index-linked portfolio if the stock price falls.
The limit also removes the opportunity for a positive effect on the portfolio from a single share being priced higher.
Most index investors prefer to be more conservatively positioned and to reduce their exposure to individual stocks even at the cost of reducing the upside opportunity.
Capping also helps with regulatory compliance, for example under CISCA rules, funds are prohibited from holding more than 35% in any one security.
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