Chapter 15: Investment indices Flashcards
Construction of indices
Weighted arithmetic indices
- Chain-linking
Total return indices
- XD adjustment
- Yield adjustment
Unweighted arithmetic indices
Geometric indices
Free float
The proportion of shares that’re freely available for purchase on the open market.
Holding period return
(P1+d)/P0 -1
- P0 and P1 are values of the investment at beginning and end of the period
- d is the income generated by the investment over the period
Unweighted arithmetic indices
AKA price weighted indices.
It is the arithmetic average of the relative price changes of the constituents.
Unsuitable as a benchmark for dynamic institutional portfolios.
The uses to which indices can be put
FINDS Best Hidden Spots
- Future movements (tool for estimating based on past trends)
- Index funds (basis for these funds)
- Notional portfolio (valuing it)
- Derivatives -basis for the creation relating to market or sub-sector of market
- Sub-sector analysis
- Short-term market movements (measure)
- History of market movements and levels given
- Benchmark against which to assess investment performance of portfolios
+SAGS (for government bond indices)
- Standard - to compare yields from other fixed interest investments
- Approximate - valuation of fixed interest portfolios
- Gap (yield gap between bonds and equities)
- Structures - picture of general yield structures of fixed interest investments
Factors to consider when specifying/creating/using an index
- purpose of index
- constituents and basis for inclusion/exclusion
- type of index (e.g. weighted arithmetic)
- frequency of calculation
- price data to use (e.g. mid-market prices)
- how to deal with capital changes (e.g. chain-linking)
- what to do about income (e.g. XD adjustments, total return indices), how to deal with tax, when to credit income, when to reinvest, etc.
UK Equity Indices
FTSE UK Index Series
Market capitalisation weighted arithmetic indices. In addition to capital and total return index numbers they give:
- Average net dividend cover
- Actual dividend yield
- Price earnings ratio
- Ex-dividend adjustment
Specific Indices:
- FTSE 100 Index
- FTSE 250 Index
- FTSE 350 Supersectors Indexes
- FTSE SmallCap Index
- FTSE All-Share Index
- FTSE Fledgling Index
- FTSE AIM Index Series
US equity indices
- Dow Jones - unweighted index
- Standard and Poor’s (S&P 500) - weighted arithmetic index
- NASDAQ
Equity indices for Japan
- Nikkei - arithmetic index
- Topix - market capitalisation arithmetic index reflecting free float (more comprehensive and suitable for performance measurement than Nikkei)
Equity indices for Europe
- DAX (Germany) - real-time total return index
- CAC (France) - CAC 40 vehicle for an index futures contract
- FTSE Eurotop 100
- FTSEurofirst 300
- Eurobloc equivalents
- Dow Jones Eurostoxx 50
Volatility indices
Used as an indication of market’s perception of risk
VIX
- weighted average of prices for a range of 30-day expiry put and call options on the S&P 500 index.
Equity indices for South Africa
FTSE/JSE Africa Index Series replaced JSE Actuaries - indices free float adjusted (based on market capitalisation previously)
FTSE/JSE Africa Headline indices comprising:
- FTSE/JSE ALSI (All Share Index)
- TOP 40
- Mid-cap index
- Small cap index
- Fledgling Index
Other indices published by JSE include:
- Sector and Sub-Sector Indices
- Secondary Market Indices
- Specialist Indices - SWIX, Style Indices, RAFI All-Share Index
Total Return Indices published end of each working day and are based on ex dividend adjustments.
International indices
- FTSE Global Equity Index series
- The FTSE Global Climate Index series
- Morgan Stanley Capital International indices
Morgan Stanley Capital International indices
Widely used series of international equity indices covering developed and emerging markets.
- calculated on market capitalisation weighted arithmetic basis
- total returns published gross and net of witholding tax
MSCI ACWI - free float adjusted market capitalisation weighted index
Fixed income indices
- FTSE Glits Index series
- FTSE Global Bond Index series
- Markit iBoxx fixed income indices
- Credit derivative indices
- South African bond indices
FTSE Glits Index series
Series covers conventional and index-linked glits.
Price, total return and yield indices are published, with indices subdivided according to term.
Index number are calculated using dirty prices (inclusive of accrued interest)
Include price and yield indices
Other international fixed income indices
- Bank of America, Merrill Lynch and JP Morgan produce indices covering many aspects of fixed income market, incl. inflation-linked and swaps indices.
- published as global/multicurrency and regional/single currency benchmarks
Credit derivative indices
Indices of credit default swaps (CDS)
- Corporate bond indices blend interest and credit risk
- CDS indices can be used by analysts and investors to monitor more directly the price of credit risk
- Cheaper to hedge CDSs/bonds with CDS index because it is standardised and more liquid than to buy many single name CDS to achieve similar effect.
Main families of CDS index are iTraxx and CDX
South African bond indices - Fixed interest bond and inflation-linked bond indices
Main fixed-interest bond index – ALBI (All Bond Index) – composite index containing top 20 fixed interest bonds
- Ranked by liquidity and market capitalisation
- Split into GOVI (Government Bond Index) – top 10 government bonds issued – and OTHI (Other Bond Index)
CILI (Composite Inflation-Linked Index) - main index-linked bond index and split into:
- Government (IGOV)
- State owned enterprises (ISOE)
- Corporates (ICORP)
ALBI and CILI - clean price index, interest yield index and total return index (assumes coupons reinvested immediately after payment)
South African bond indices - Credit indices
Credit Indices produced by JSE for corporate bonds.
- Three indices include Credit Fixed, Credit Floating and Credit Composite.
- Credit composite Index – weighted average index of Credit Fixed and Credit Floating Indices
Money market instruments – Short Term Fixed Interest (SteFI) Composite Index is used.
- Benchmark index for cash equivalent investments and now calculated & published daily by South African Futures Exchange (SAFEX)
Problems when constructing indices of unlisted or illiquid assets
- Lack of reliable and up-to-date price data
- Heterogeneity of assets included
Problems in obtaining price data in frequent intervals for illiquid or unlisted asset indices
- Unique - not representative of sector/asset class overall
- Market value is only known for certain when the asset changes hands
- Subjective, expensive and time consuming estimation of value
- valuations may be carried out at different points in time, not necessarily st time the index is calculated
- infrequent sales of certain assets - interim values need to be estimated or determined by suitable valuation expert
- prices agreed between buyers and sellers are normally treated with a degree of confidentiality
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
Merits of barometer indices
- Subjective estimate (of rack rents) for hypothetical properties
- Thus, should give an earlier indicator of changes in market rent levels
- Unsuitable for portfolio performance measurement - (Investor unable to closely match with an actual portfolio)
- Highlight short-term changes in level of the market in terms of rents and yields
Property index providers
Divided into residential and commercial indices
Commercial indices further divided into industrial, office and retail categories
IPD is leading index provider for commercial property indices (used for pricing property derivative contracts)
Alternatives to property indices
Collective investment schemes investing in real property.
- May have issues surrounding regular valuation.
- A large scheme withwide range of investments may be trading and valuing sufficiently frequently to smooth out main difficulties
- Use published prices as a proxy for an index
Adjust prices for regular management or other charges.
- Many schemes invest significantly in property company shares and real property - distort results.
