The benchmark is about to change

By NZPA

Friday 4th October 2002

The yardstick sharemarket index, the NZSE-40 Capital Index, whose antecedent, the Barclays Index, goes back to 1957, is about to get the chop.

The Stock Exchange has proposed to revamp that and other indices as part of its campaign to rejuvenate itself and the market.

The rejig will expand the benchmark index from 40 to 50 stocks, stocks will be weighted according to free-float (shares available to the public), not market capitalisation, and the index will be a gross (accumulating for dividend payments), not capital.

Indices are arbitrary groupings of stocks but are useful to measure the overall performance of the sharemarket. Fund managers use them to benchmark their performance and some funds, such as the tax-favoured passive funds, track indices precisely.

No one need use the exchange's indices -- indeed most overseas fund investors mostly track the 12-stock Morgan Stanley Capital Index -- but they can be a useful branding tool as the Dow Jones Index is in the United States.

Assuming the NZSE-40 Capital Index goes, investors will lose the 45 history to measure the New Zealand market against others.

Motives for change sound solid. It is part of a package including exchange demutualisation (discussed last week) to try and attract more investors to the market and increase turnover.

The exchange believes a capital-based index is "inappropriate for a country with an extraordinarily high dividend payout".

"The market's preference and the clear global preference, is towards free float indices, which increase the investability of indices," the exchange says in its discussion paper.

A 50-stock headline index would be more representative of the breadth of listed companies listed and would more accurately reflect performance, exchange chief executive Mark Weldon said.

He said it was a top priority to make the indices "highly visible".

All going well, the new indices will come into play on January 1.

Mr Weldon is a man in a hurry to improve the exchange's performance and to make the sharemarket more appealing. That is laudable, but he may come unstuck in his rush to change.

He said discussions had already been held with local fund managers and some companies and in general they supported the changes.

But fund managers NZPA spoke to had big questions over many of the proposed changes.

Although the exchange says there is a world trend towards free float issues, most headline indices are not, and there is a suggestion the exchange is attempting to hide the poor performance of the New Zealand sharemarket in capital terms.

The NZSE-40 Capital Index has essentially been mired between 1850 and 2400 points for nine years -- a period that has included the greatest bull run in Wall Street history. The market's total capitalisation is $42.6 billion today against $58 billion five years ago and $27.4 billion a decade ago.

However, exchange marketing manager Geoff Brown argues gross return indices (including capital appreciation and dividends) are a fairer measure, particularly in New Zealand with its history of high dividends. Most analysts agree with him and fund managers already concentrate on the gross indices.

"We were only ever capturing part of that return when we looked at the capital index," Mr Brown said. "It's not a PR job. As an investor, the thing that you are most interested in is your total return." The Dow is up 140 percent from March 1992 when it began its famous bull run, but is 31 percent off its 11,301 peak in May 2001.

The NZSE-40 gross index rose 268 percent over the same period and interestingly is only 7 percent off its peak.

New Zealand's concentration on yield has its critics -- that it discourages companies reinvesting and expanding -- and lack of growth has certainly been a problem for the exchange.

"The question I haven't been able to answer for myself is just why the payout ratios are so high. It could be that companies themselves don't have things they want to invest in and therefore don't have needs for the funds and are happy to pay it back," Mr Brown said.

He believes moving to a free-float basis is the most important proposed change. This means shares locked up by a large shareholder in a stock are not counted in the stock's weighting. The most extreme example is Air New Zealand, which is 82 percent owned by the Government.

Other stocks will have their weightings heavily trimmed including current No 2 stock Carter Holt Harvey, half owned by International Paper, Ports of Auckland, 80 percent owned by Infrastructure Auckland, Sky TV 66 percent owned by INL and 12 percent by Telecom and Contact Energy, half owned by Edison Mission.

Telecom, already the Godzilla of the market with a massive 21.7 percent weighting will, because of its open register, actually see its weighting increase to 26 percent.

Another big change is to reformat the top 10 index to an equal weighting for each stocks. The aim is to use that index as the basis for a viable derivatives product. The once actively traded stock market futures -- which most markets have -- virtually died after the 1987 sharemarket crash.

Tower Asset Management equities investment manager Wayne Strechman supports moves to a gross index and to a free-float basis.

Like others, he doubts the value of expanding the index to 50 stocks because of the small size of companies at the lower end of the index.

He is against stocks in the top 10 index being equally weighted.

"For a derivatives market to be active, it needs to as closely as possible replicate what people do -- what their physical portfolio is."

Alliance Capital fund manager Darryl Briggs agrees change is needed. However, he feels the main index should be shrunk to 30 stocks, not expanded, and he is against the free float which he believes could be a temporary fad.

He would prefer to reverse the exchange's concept and use free float to screen index entry and then weight according to capitalisation.

"In my view market capitalisation is hard to beat. It recognises the underlying value of the company. The very reason people chose to take significant stakes in companies which are deemed secure is that the company is significant."

The free float has essentially been designed to circumvent the inclusion of the tightly held Air New Zealand, NZ Refining and Power New Zealand and a more pragmatic decision should be made simply to exclude those stocks.

Mr Briggs believes free float is too distortionary and would open the market up to "gaming" -- manipulation.

Changes to the top 10 index might attract more foreign investment although local institutions may find it less useful as a hedging tool if it is equally weighted.

He doesn't like other proposals such as the 5 percent proposed limit on the weighting Australian stocks registered in New Zealand or the artificial weighting limit at 80 percent of stocks worth over $1 billion.

"I would hope that it is early days. There are several suggested rules which certainly don't look like they are that good," he said.

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