Ch 14 - Investment Indices Flashcards
Weights are often restricted to reflect the level of free float of shares available for purchase, thereby…
eliminating strategic holdings
Chain-Linking is set up so that:
The index does not change as a result of market capitalisation and only measures investment performance as intended
Circumstances in which chain-linking would be required include:
Rights issue or a share buy-back by a constituent company
New issue of a share in the sector covered by the index (newly-formed company, privatisation, demutualisation)
A merger, takeover or break-up involving constituent companies
A change in the constituent companies in the index (100th largest falls out of index, etc)
Unweighted Arithmetic Indices:
Otherwise known as a price-weighted index.
It is the arithmetic average of the relative price changes of the constituents.
Why is an unweighted arithmetic index unsuitable as benchmark for dynamic institutional portfolios (i.e. as performance measurement)
Because the performance of any investment portfolio will reflect the actual weights (market caps) of the constituent companies held within that portfolio, which are unlikely to ever be equal
Merits of an unweighted geometric index
Easy to calculate - Only need price data
Gives indication of short-term price movements
Unsuitable as a benchmark for investment strategy or portfolio investment measurement
e.g. if one price goes to 0 then the whole index does as well
Hence, constituents need to be changed to avoid this happening
Uses of indices:
Sarah Hannah Baker FINDS indices useful
Short-term market movements
History
Benchmark
Future movements (tool for estimating) Index funds (basis for these funds) Notional portfolio (valuing it) Derivatives -basis for the creation relating to market,etc Sub-sector analysis
+SAGS (for government bond indices)
Standard - to compare yields from other FI investments
Approximate - valuation of fixed interest ports
Structures - picture of general yield structure
Gap (yield gap)
Factors to consider when specifying/creating/using an index:
Purpose of the index
Constituents and basis for inclusion/exclusion
Type of index
Frequency of calculation
Price data to use (mid-market prices?)
How to deal with capital changes (e.g. chain-linking)
What to do about income, tax, reinvestment date, etc
Property price indices are very difficult to maintain because:
Lack of reliable and up-to-date data on property prices
Heterogeneity of properties
The problems involved with obtaining market values for property include:
Unique
Market value is only known for certain when the property changes hands
Subjective - Estimation of value
Expensive and time-consuming - Estimation of value
Infrequent valuations
Infrequent sales of certain types of properties
Confidentiality - Prices agreed between buyers and sellers of properties are normally treated with a degree of confidentiality
Problems with using surveyors’ valuations as an alternative to actual sale prices (for property index creation):
Subjectivity
Cost
Circularity
Types of Property Indices:
Portfolio-based indices
Barometer indices
Portfolio-based indices
Measure rental values, capital values and total returns of actual rented properties
Rates of return are money-weighted
Underlying portfolios will vary according to size, regional spread, sector weighting (office, retail, etc), direct vs indirect, prime and non-prime, tenure(freehold or leasehold)
Merits of portfolio-based indices
Current rental income is fixed until the next rent review - Sluggish response to movements in rental values
Timing and magnitude of cashflows into a property will influence the results - because MWRR
Mainly used for performance measurement
Barometer indices:
Aims to track movements in the property market at large by estimating the maximum full rental values of a number of hypothetical rack-rented properties
