GLOBAL - The Johannesburg Stock Exchange's adoption of the FTSE index system in June 2002 appears to have solved one problem, but created another.
The benchmark FTSE/JSE Free Float index promised to promote greater liquidity by excluding shares held for strategic or cross-holding purposes (unlike its predecessor, which was based on total market capitalisation).
Retirement fund managers have agonised over how to rebalance their portfolios following the introduction of the new index, which is heavily weighted in volatile resources stocks.
As the accompanying table shows, the six biggest shares on the JSE now account for 52.7% of the total market weighting, versus the previous 43.7%.
Anyone surveying the crumpled corpse of Enron - whose pension fund was more than 60% invested in Enron stock - understands the risks of such concentration.
Many Enron employees ended up not only jobless, but destitute.
Anglo American now accounts for 18.9% of the FTSE/JSE Free Float index, against 15.7% under the previous system. BHP Billiton's weighting is up from 8.4% to 10.1%.
While this resources bias has flattered investment performance over the last two years, many fund managers are uncomfortable with such a large weighting in historically volatile shares.
Further muddying the picture is the imminent rewrite of Regulation 28 of the Pension Funds Act, which sets investment limits on different asset classes.
The latest iteration would limit funds to 5% exposure in any single share, making it impossible for retirement fund managers to replicate the FTSE/JSE Free Float index.
The JSE has promised to develop a new index which more accurately reflects the investible universe, given that more than half the shares in 10 largest companies are held abroad, beyond the reach of local investors.
In the meantime, two local financial services firms - Alexander Forbes and Peregrine Quants - solved the problem by developing a new benchmark index which down-weights the JSE's dual-listed shares, counting only those shares locally available for trade.
The new benchmark, the Alexander Forbes Equity Index SA (AFEISA), has been adopted by several pension funds as a tool to reduce risk and assist portfolio construction.
Given its reduced weighting in resources stocks, the AFEISA index has proven to be less volatile than the FTSE/JSE equivalent.
The accompanying table shows the respective weightings of the old JSE actuarial index, the new free float index, and AFEISA.
Pension funds adopting this index for asset allocation purposes will have to load up on financial and industrial stocks to compensate for the reduced weighting in resources.
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