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Why a new free float index for the JSE?

By Craig Pheiffer

The introduction of the FTSE/JSE Africa Index series on June 24 brings SA into line with global best practice in terms of market index construction.

The new series is based on FTSE’s global classification system and a system of free float. No less an index than the German Dax coincidentally underwent a similar free-float revision to its indices on June 24. The use of the global classification system means that investors will have to get used to possibly finding their favourites stocks housed in new sectors.

Sasol and Sappi, for example, will no longer be found in the Resources sector (now called an economic group) but rather in the economic group called Basic Industries. There are now ten economic groups divided up into 37 sectors which are further divided into 103 sub-sectors.

The system of free float will also impact the new indices in that the weightings of each index will be based on the number of freely tradable shares in each index’s constituent stocks. A stock’s free float is reduced by cross holdings, tightly held family control and shares locked up in employee incentive schemes, for example.

In the case of Impala, where Gencor holds over 40% of Impala’s issued shares, the low free float will result in Impala’s weighting in the new indices being reduced. Should Gencor unbundle those shares then Impala would qualify for greater participation in the FTSE/JSE Africa Index Series.

The shares with the greater free float will therefore have the greater part of their market capitalisation included in the new indices. There is a fixed scale dictating how free float percentage translates into participation in the new indices but constituent stocks with free float percentages greater than 75% will have their entire market capitalisation included in the new indices.

While the introduction of the new system is to be applauded, it does raise some problems for asset managers who use the indices for benchmarking the performance of their funds.

Under the new regime Anglo American with its high free float, for example, will see its weighting in the All Share index rise above 20%. This raises problems for asset managers of retirement funds given local prudential guidelines.

The JSE is aware of that problem, however, and will look into the construction of a more appropriate benchmark once the new indices have been bedded down.

  • Craig Pheiffer is Chief Investment Strategist at Sasfin Frankel Pollak Securities. he can be contavted on tel. (011) 883 2337 or by e-mail on mailto:cpheiffer@sasfin.com

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The Big Change is a business strategy blog and newsletter published by Arthur Goldstuck, managing director of World Wide Worx, a leading technology research organisation based in Johannesburg, South Africa.

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