Casparus Treurnicht – Portfolio Manager

July 2019

We’ve all heard this saying before and it can be interpreted from various perspectives. Currently, of extreme relevance is the newly elected President, Cyril Ramaphosa, and his cabinet who will be focusing on macroeconomic- and fiscal policies to promote the economic wellbeing of the Republic. Should they succeed in improving the economy (the tide), all citizens, businesses and state-owned enterprises should benefit (the boats).

Locally listed assets should also benefit from an improving market (the tide) with some posting returns better than the market and others not delivering at all. But this begs the question: What exactly is the market? And what index should we make use of in order to compare the performances of individually listed assets?

For an index to be recognised, it must meet a range of criteria. The most important of which are that it must be:

· systemic,

· investable, and

· transparent.

We summarise it as follows:

A predefined set of rules specified in advance will ensure all market participants will be able to determine index constituents and weightings assigned to them for any time period in the present or past. By providing market participants with same data, all value decisions can be made equally. Index constituents are not dependent on emotion and inclusion is based on quantifiable market data and criteria. Every stock included in an index must be investable. (et voila: rules-based investing)

However, there is another characteristic that deserves attention: The market (or index to be constructed) needs to be representative (reasonably and fairly representative of a wide-enough range of tradeable stocks) otherwise using it for performance comparison becomes moot. As at the end of June 2019 the FTSE/JSE Top 40 Index (J200T) consisted of 42 stocks in comparison to 164 included in the FTSE/JSE All Share Index (J203T). This means that 17% of the All Share Index’s market capitalization is not accounted for by the Top 40; a chunk that makes a meaningful difference in performance over time, as illustrated in the graph below:

Source : Iress Igraph

What we must ask ourselves is, what is representative? In order to achieve a tradeable and liquid index we cannot include every single stock in the market due to some stocks being too illiquid and others not trading at all. As mentioned previously, this means that a portion of the market is disregarded even though it contributes to performance. Gryphon’s methodology is based on liquidity and, as a result, a number of shares included in the FTSE/JSE All Share Index that are too illiquid for us to include in our passive methodology. One can just imagine the implications of Illiquidity for investors, come the time when those shares need to be liquidated and there are no buyers available in the market. Transaction costs and market impact costs are significant when trading in small volumes. Based on a range of criteria, Gryphon only invests in companies having sufficient sustainable liquidity in order to track the performance of the FTSE/JSE All Share Index:

Source: Profile Media / FE Analytics

87.8% of all fund managers in the General Equity Sector underperformed the Gryphon All Share Tracker Fund for the ten years to June 2019. This figure does not take into consideration the funds that were closed, in which case the percentage would be even higher. If a fund manager uses poor markets as an excuse for a lack of performance, perhaps it will become more apparent that very few managers can offer more than what the tide can provide. More so, indexation becomes a core option in securing returns in line with the stock market.

It is interesting to note how the different methodologies used by different index providers result in varying weights being assigned to some stocks in the indexes that they construct. Namely, at the end of May 2019:

· MSCI South Africa index: 32% weighting in Naspers,

· Satrix SWIX Top 40: 30% weighting in Naspers,

· FTSE/JSE All Share Index 19% weighting in Naspers,

· This, even though the market only traded 17.65% of its value in Naspers.

The Naspers Dilemma

Naspers is in the process of moving its international assets to a primary listing in Amsterdam. Although it is still too soon to know what the exact impact will be, all indications thus far are:

· The All Share Index is least likely to change; at most it will experience a small down weighting of Naspers.

· Capped indexes will experience an increase in their net/total allocation to Naspers assets due to two companies now being listed.

· The SWIX variants will lower their allocations to Naspers assets as a chunk of the listing would go to foreign shareholders.

What we expect to happen is that the SWIX and Capped Indexes will have their constituent weightings move closer to the All Share Index.

We are steadfast in our belief that the All Share Index is the most representative benchmark of the broad market over time (the tide). Investors who believe in indexation (only smart investors do) should therefor ensure that the index fund they buy tracks the All Share Index.