Improving market capitalisation indices in South Africa by using a moving average instead of the current market price

Abstract

This research report investigated an alternate method to constructing the Top 40 market capitalisation index on the JSE by using various moving averages of each constituent’s market capitalisation. The performance and risk characteristics of each of these indices were then compared to that of the market capitalisation weighted index as well as the equally weighted index. The study was a quantitative study using a Monte-Carlo simulation as the research instrument to evaluate the results. The main findings of the research is that the moving average indices that were constructed did not really add value when compared to the market capitalisation weighted index but did add value relative to the equally weighted index from a performance perspective. From a risk perspective the research found that the equally weighted index was less risky than both the market capitalisation weighted indices as well as the moving average indices constructed. Analysing the results by looking at some of the contributions of individual shares to the various indices showed that a small number of shares seemed to have had a strong contribution to the result. However the research could not find a reasonable method for identifying these shares in advance and therefore did not make alternate conclusions based on excluding these shares. Therefore the result that the market capitalisation weighted index is superior to the moving average indices considered in this study is the most reasonable conclusion that can be made following this research. A potential extension for future research that could make an alternate method for constructing the moving average indices more viable by taking into account the cyclicality of individual stocks or sectors has been suggested based on the contributions of individual stocks to the result of this research.