Get ready for a new-look Alsi

As early as March next year, the FTSE/JSE All Share Index (Alsi) could start to look a little different. This is if proposed changes to the index continue to receive a positive reception.

The JSE issued a note to market participants last month setting out a number of proposals that it believes will make the local indices more relevant. Mark Randall, the manager of indices and valuations at the JSE says that so far these have been generally well received, and they are hoping to make a final decision on their implementation by February next year.

That could lead to the new-look indices being implemented from March 2016, but if more discussions need to take place this may be pushed back to the quarterly reviews in either June or September.

“The Alsi and the Swix have been running under their current rules since 2002 and 2004 respectively,” Randall explains. “Broadly, they have been successful, but markets do evolve over time and we are looking at whether we can tweak the rules slightly to keep them relevant for the next ten years.”

He says that, initially at least, while the changes may seem large in principle, their numerical impact is relatively small. However, they will hopefully mean that the indices are more tuned to what market participants need them for.

Differing purposes

The most important thing for investors to understand is that the JSE intends gearing different indices for two distinct purposes. The first is that the Alsi, a new Large & Mid Cap Index, and the Small Cap Index will specifically be designed to serve as benchmarking tools – in other words a market standard against which investors and fund managers can set mandates or measure performance.

The Top 40 and Mid 60, on the other hand, will have different rules that will make them more appropriate for being used for index products – specifically the likes of exchange-traded funds and derivatives.

“We have always used the same rules for both sets of users,” Randall explains. “However, perhaps we need to be more cognisant of the specific needs of product writers versus benchmark users.”

For benchmarking

In order to understand what this means, it is necessary to break down the proposals.

The most significant is to remove the minimum free float requirement that currently exists for inclusion in the Alsi. This will be replaced with a minimum index weight requirement.

What that means is that, currently, to be included in the index a company must have a certain percentage of its shares available on the local market. However, that ignores what those shares might actually be worth. The JSE therefore wants to change this to take into account the size of the free float relative to the rest of the market, rather than simply relative to the company itself.

The rationale for this is that there are a number of large companies with secondary listings on the JSE that are unduly affected by the free float rule. Those most particularly affected at the moment are Glencore and South 32, which despite being frequently traded here and being large enough to be included in the Top 40 by total market capitalisation, are not currently in any local benchmarks.

It also needs to be considered that just because there is a small local free float does not mean that local investors couldn’t buy more shares in these businesses if they wanted to.

“If a South African investor wanted to buy 10% of Glencore they could buy it overseas and transfer it to the local share register,” Randall says. “So that minimum free float rule doesn’t really work for these kinds of companies.”

To go along with this proposal, the JSE is suggesting that the Alsi should no longer have to be made up of a minimum of 160 stocks. At the moment, the index is effectively a combination of the Top 40, the Mid Cap Index of 60 stocks, and the Small Cap Index of another 60 stocks.

However, its primary aim as an index is actually to capture 99% of the market. The problem is that the 99% market representation and the absolute number of 160 stocks don’t always align.

“The 99% market representation can sometimes get us to around 150 stocks,” Randall explains. “That leaves us with the scenario where we have to fill up the index to get to the minimum of 160.”

The proposal from the bourse is that the ALSI should rather deliver the 99% market representation, regardless of how many stocks that is. In order for this to work, the indices that effectively make up the Alsi will also have to adopt the same approach. To do this, the JSE would like to introduce a new index, called the Large & Mid Cap Index, and change the rules governing the Small Cap Index.

“We would fix representation to say that the Large & Mid Cap Index should capture 95% of the market, and the Small Cap Index should capture from 95% to 99%,” Randall says. “So the indices become fixed in capturing a proportion.

For product providers

With those indices specifically acting as benchmarks, the Top 40 and current Mid Cap Index, which will be re-named the Mid 60, will be ‘carved out’ as tradable indices. In practice, this means that instead of focusing on the absolute size of companies, they will focus on their “investability”.

This means selecting them entirely based on their net market capitalisation, or free float.

The rationale is to ensure that these indices will be selected and weighted on the same factor, reduce the concentration in the indices, and improve their liquidity. Practically it might mean that larger companies with lower free floats, such as Anglo American Platinum or Capitec could potentially shift down to make way for those with higher free floats such as Truworths and Gold Fields.

Randall says that the JSE is currently engaging with market participants and inviting comments on these proposals. The exchange is encouraging everyone to have their say to facilitate the process of making the indices more appropriate and more useful.

“At this stage these are really proposals,” he says. “So the more feedback we get from the market, the easier it will be.”

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