The application of fundamental indexing to the South African equity market for historical data dating back to 1996

Ferreira, Rickus (Stellenbosch : University of Stellenbosch, 2009-03)

Thesis (MComm (Business Management))--University of Stellenbosch, 2009.

Thesis

Measuring the performance of any financial portfolio is only relevant if compared relative to another similar portfolio. Over the years the norm in the industry has been to use market capitalisation indices as benchmarks to measure performance. Market capitalisation indices, such as the FTSE/JSE ALSI, create a natural return drag because of the overweighting of overvalued stocks and the underweighting of undervalued stocks. It is this return drag that led to the creation of the Fundamental Indexing concept by Research Affiliates in 2005. Fundamental Indexing weights stocks based on their economic footprint in the market rather than their market capitalisation. The Fundamental Indexing approach uses four metrics, namely sales, book values, dividends and cash flows to calculate this economic footprint. The Fundamental Index is referred to as the RAFI (Research Affiliates Fundamental Index) Index The Fundamental Index concept delivered very good results when applied to the South African stock market. The South African RAFI Composite Index outperformed the FTSE/JSE All Share Index by 5.55% p.a. compounded annually during the period 1995 to 2006. This return was achieved with a similar risk profile as the FTSE/JSE All Share Index. This index also had similar turnover rates relative to the FTSE/JSE All Share Index. The South African RAFI Composite Index also outperformed the FTSE/JSE All Share Index by 5.48% p.a. compounded during the measurement period when investment income is included. The Fundamental Index outperformance clearly disproves the efficient market hypothesis. According to modern portfolio theory it is impossible to earn abnormal profits in excess of a market capitalisation index. The success of Fundamental Indices proves that market capitalisation indices are not optimal and deliver sub-optimal returns. Specifically, it can be seen that the South African market is inefficient and that the FTSE/JSE All Share Index is not the best tool for measuring the performance of the financial markets in South Africa.

Please refer to this item in SUNScholar by using the following persistent URL: http://hdl.handle.net/10019.1/3022
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