And that is why brokers get the benchmark thing wrong…

Oh, how we yearn for simpler times when a benchmark (sic) was something we left on the porch veneer after dragging our recliner to better enjoy the late afternoon sun … and a skid-mark was something we left on the tarmac after abusing the handbrake in our then petrol-guzzling motor car. Alas, in the world of investing, these words have different meanings. A benchmark is ‘a standard against which the performance of an investment portfolio or investment manager can be measured’ while a skid-mark … well, that’s a private matter between you and your dry cleaners, often immediately following a stock market collapse!

The benchmark aberration

Today’s musings about benchmarks follow an informative presentation by Kingsley Williams, Chief Investment Officer at Satrix, to The Investment Forum 2021. Williams took the opportunity to explain some of the unique challenges that South African asset managers and financial advisers face in setting benchmarks and reporting on funds’ performances against these hurdles. “It turns out that your choice of benchmark is one of the most active investment decisions you can make, which puts paid to the notion that index tracking is a purely passive game,” said Williams, reminding the audience that there were four main equity benchmarks in play locally. He opined that the choice of benchmark may cause a significant expectation gap between financial advisers and their clients. 

The most popular domestic equity benchmark, based on Google’s search analysis tool, is the JSE ALSI. This index is searched four times more often than the second most popular, the capped variant or CAPI… The third and fourth indices, the locally-focused SWIX and Capped SWIX, hardly feature in the search engine landscape. But why should financial advisers care about consumers’ popular perceptions of JSE indices? Williams was keen to explore how the popularity of one or other benchmark might affect how investors’ viewed their market returns. “An investor may have one return in mind, based on the published returns for the ALSI; but have an entirely different investment experience due to their investment manager using another benchmark,” he said. “Hence the title of my presentation: Mind the benchmark gap”.

Similar market exposure; mixed returns

I was quite intrigued by Williams’ introduction. I mean, how different might returns be based on whether I measure a basket of equities against the ALSI, CAPI or SWIX as a benchmark? It turns out that some inter-index differences would wipe out the entire active risk budget entertained by most active fund managers. To make matters worse, these indexes are in a perpetual dance, jumping between outperform and underperform depending on underlying market conditions. 

“The ALSI and CAPI historically lag the SWIX and Capped SWIX by some margin, though more recently they have closed the gap,” said Williams, illustrating the difference using charts of rolling three-year annualised returns for each index between 2005 and 2021. The CAPI performance, relative to ALSI, ranges anywhere between -2% and +2% with a realised tracking error of 1.4%; for the Capped SWIX, this range expands to -6% and +6% with a realised tracking error of 4%. There are a handful of reasons for the performance divergence, mainly due to differences in index construction; but before exploring these differences, Williams felt it worthwhile examining how financial, industrial and resources sector weightings affected returns. 

“There was a significant widening of the outperformance of the industrial versus financial sector in 2020, largely due to the leveraged play that financial shares represent on our local economy and the challenging economic environment we have endured; but this is not enough to fully explain the divergence in performance between the four main market indices,” he said. It seems the answer lies in commodities or resources. The SWIX and Capped SWIX tend to underperform both the ALSI and CAPI whenever the resources sector outperforms the industrial and financial sectors. South African investors saw this in 2008-2009 and again in 2017-2018. However, when resources underperform, as they did between 2011 and 2017, the SWIX and Capped SWIX tend to outperform the ALSI and CAPI. 

China offers its 10-Cent worth

Sector performance, and more importantly sector exposure, is thus the main contributor to the return dynamic between the four benchmarks. The ALSI and CAPI have slightly higher weightings to the old JSE dual-listed shares such as Anglo American, BHP Billiton, Richemont and a few others. These indices are closely matched in terms of their exposure to the resources sector, at around 35%, with the former having a 20% exposure to technology stocks compared to the CAPI’s 12%. These similarities explain why the ALSI and CAPI performance is so closely aligned. The SWIX, in contrast, down weights exposure to the dual-listed companies based on the proportion of shares held locally on STRATE. “Companies with JSE-only listings end up having a higher weight in SWIX, with more than half of its industrial exposure due to its weighting to Naspers and Prosus,” said Williams. 

He pointed out that if economic growth surprises to the upside it will be good for the Capped SWIX, whereas CAPI is best positioned to benefit from the current commodities bull market. Lastly, if you reckon 10-Cent is going to shoot the lights out, then the ASLI and SWIX are going to deliver. 10-Cent is the Chinese share that accounts for the bulk of Naspers’ value. In this context, the choice of benchmark ends up being an active decision which could, perversely, make the returns on an investment portfolio appear stellar or pedestrian, depending on a range of underlying factors. “There may be an expectation gap in clients’ minds relative to how managers construct or benchmark their portfolios, leading to potential disappointment and possibly difficult adviser / client conversations,” said Williams. 

Active / passive versus empowered investors

Satrix does not believe in active versus passive, preferring to empower investors to construct and tailor their portfolios to meet their specific needs. They argue that indexing is more efficient and cost effective in providing both core beta exposure and exposure to strategic factor risk premia. The conclusion: “Active managers still have the opportunity to differentiate themselves by offering purer sources of alpha that are not easily captured through indexing or a systematic approach. These include thematic investing or investing in opportunities in alternative spaces such as private equity and hedge funds”. 

Writer’s thoughts:
The key disclosure document or fund fact sheet published alongside unit trusts and other passive products are always benchmarked against one or other index. We used to think of the ALSI as the ‘go to’ for equity fund benchmarks; but clearly that is not the case… Are you overly concerned by your client’s investment portfolio performances compared to fund benchmarks – or do you prefer to track the entire portfolio against longer-term, investor-related return targets? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts editor@fanews.co.za.