Picking a measure to assess sharemarket returns

By Peter V O Brien

Friday 7th September 2001

Broker ABN Amro Craigs' research department has joined the old debate about an appropriate measure for assessing the sharemarket's performance and its historic returns.

A recent research paper discussed the matter but, in an apparent attempt to jazz up the document and anchor its main proposition, it started with a silly cheap shot at TV One's newsreaders.

The paper was headed "Richard [Long] and Judy [Bailey] - You're looking at the wrong Index!"

"Every night at 6pm TV One News kindly tell [sic] us the movement in the NZSE40 capital index. This is a waste of time ..." Later the paper reads "Richard and Judy are misrepresenting the market performance and misleading Kiwis when they show the capital index each night."

TV newsreaders may be overpaid and under-worked. But that is irrelevant in this case.

It is worth noting National Radio's summaries of sharemarket activity include voiceovers from individual brokers who always refer to movements in the NZSE 40 capital index, as does London's Financial Times in its table of world sharemarket indices by country. Are they misrepresenting things and misleading Kiwis?

ABN Amro Craigs' main argument was that "the performance of the NZSE 40 Capital Index is not a fair reflection of the returns from the New Zealand market."

That sentence raised the question of what an index is supposed to do, what "performance" is and whether various definitions of that word are synonymous with "returns."

The Stock Exchange has 10 general indices, apart from industry sector indices. They are: NZSE 40 capital and gross, top 10 capital and gross, NZSE 30 capital and gross, NZSE SCI (small companies) capital and gross and NZSE all ords capital and gross.

Which is the "right" one, given they are all official indices emanating from the Stock Exchange, of which ABN Amro Craigs is part and its boss the chairman.

There is no "right" index; selection depends on what one wants to measure. Gross indices, as the brokers said, measure the total "return," including dividends.

Capital indices measure changes in basic share prices, or the movements in the capital value, excluding dividends, of the stocks in the index.

Gross indices and capital indices are different sized "animals." Each comprises a "herd" of different animals, with big daddies, smaller mummies and some adolescents.

In the case of gross indices, the dividends could be represented in gross indices as the pre-adolescents, but they are excluded from the capital indices, so each herd is different.

Irrespective of which herd is used, they are groupings, or weighted averages and therefore may not be a guide to the capital performance of, or total returns from, a specific portfolio.

A discussion of the first six months of this year in NBR Personal Investor, July 6, listed the 10 top performers in terms of share-price movements from January 1 to June 26.

Percentage increase ranged from 233.3% (Mooring Systems) to 37% (Designer Textiles), with the other stocks being PDL (189.2%), Richina (87.2%), Software of Excellence (73.7%), Vending Technologies (66.6%), Cabletalk (50%), Fisher & Paykel (46.6%), Reid Farmers (44.6%) and Wrightson (41.2%).

The NZSE40 capital index increased 7.6% in the period, the NZSE 40 gross 10%, the small companies index (SCI) capital 6.7% and the SCI gross 13.3%.

ABN Amro Craigs' analysis was valid in the sense that gains over the years in the NZSE 40 gross were better than the 40 capital but it compared indices which had different underlying bases.

The paper was useful in making several points sometimes overlooked.

It said New Zealand remained a relevant asset class in portfolios and that most local investors should retain a good exposure to the New Zealand market.

There were obvious limitations to investment in New Zealand in terms of size, lack of diversification, limited sector representation and, in many cases, limited earnings growth prospects.

Currency exposure in the New Zealand dollar was an additional risk that should not be underestimated.

Those factors must be overcome through investment diversification into the larger, faster growing markets of Australasia, Europe and the US.

Investors should still utilise advantages offered in the New Zealand market. They were:

The availability of imputation credits attached to dividends which some investors can use the offset other taxable income;
The high payout ratio and resulting dividends which cushion overall return during periods of market underperformance; and
The ability to know and understand local companies, how they conduct business and the economic and political environment in which they operate.

The firm said the New Zealand market had performed not too badly over the past10 years "when measured correctly" and had outperformed some international markets in recent years.

Somewhat strangely, the paper ended with a soft comment after the hits on television newsreaders and - probably - others.

"Whilst the headline index in New Zealand is likely to remain the NZSE 40 Capital Index, don't forget the importance of the gross index when assessing true performance."

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