Relative performance of fundamental indices on the South African equities market .

Abstract

In portfolio construction, the objective is to seek optimising returns while minimising risk. The evolution of capital markets has led to sophistication with research on scientific ways of stock picking using various metrics, among them indexation. The proponents of indexation suggest that it is a straightforward way to participate in the broad equity market due to the following factors: low turnover, low cost, relatively low management fees (compared to the fees charged by active managers). At the advent of indexation, market capitalisation weighting index construction methodology dominated index portfolios. In both the global and South African investment industries, it is a popular methodology, albeit with various variations. The fundamental indexation methodology bias is to invest in companies that are expected to deliver positive returns based on strong firm centric fundamentals to maximise return. The purpose of this study is to establish which portfolio construction strategy between fundamental indices and market cap weighted indices performed better in emerging markets during different market cycles using the South African equities market as a proxy. The time period covered is pre-financial crisis, post-financial crisis and over both time periods. The pre-financial crisis period is between 1st October, 2007 – 31st December, 2013 (Table 4.2) while the post-financial crisis is the period between 1st October, 2007 – 31st December, 2008 (Table 4.3).The entire period of study is between 1st October, 2007 to 31st January, 2016. The share price data was collected and organised in Excel for both RAFI 40 index and Top 40 index. The Excel sheets have macros to enable data calculations in order not to have incorrect outputs by showing no price movements on non-trading days such as holidays. The study questioned whether there is outperformance by using a fundamental index as a portfolio construction strategy over market weighted index by evaluating the portfolio returns of RAFI 40 vis a vis the Top 40 index. The rationale was to establish which strategy delivers superior returns over different market cycles.