Yet, within these categories, managers can measure themselves against a variety of different benchmarks. Funds in the South Africa equity general category, for instance, are using six different major benchmarks, and a variety of others.

These include the category average, the FTSE/JSE Shareholder Weighted (SWIX) Index, the FTSE/JSE All Share Index (ALSI), the FTSE/JSE Capped SWIX Index, and the FTSE/JSE Capped All Share Index.

“There is a lot of fragmentation in benchmarking in South Africa,” says Chris Rule, head of products and client solutions at CoreShares. “In the US, large cap equity funds would almost all be benchmarked against the S&P 500, and in the UK they would use the FTSE 100. But here, there isn’t one dominant benchmark.”

Rule believes that this has a lot to do with how indices in South Africa have developed. For many years the ALSI was the standard, however in 2003 the JSE, in partnership with FTSE Russell, launched the SWIX, and the Capped SWIX was introduced in 2016.

Over time, some managers stayed with the ALSI, while others migrated to alternatives which they felt addressed some of the structural issues in the local market like over-concentration and the influence of big foreign stocks.

Making a choice

This raises questions about how much this should concern investors. Does your fund managers’ choice of benchmark matter?

Takalani Mashau, investment analyst at RMI Investment Managers believes that it does.

“Benchmarks are an important part of the ‘contract’ that is agreed upon when someone decides to put their money with an investment manager,” Mashau points out. “The manager is rewarded for outperforming the benchmark – whether that’s through performance fees or through loyalty. But, some benchmarks are somewhat inappropriate and not really working well for either investors or asset managers.”

For instance, the value of using the unit trust category average as a benchmark for equity funds is questionable. Not only is this, over the long term, a relatively unchallenging standard to beat, but it is also not something that anybody can invest in.

“From a fund buyer perspective, the benchmark should be your starting point,” argues Rule. “You have to believe that the manager you are choosing is good enough to beat that benchmark, otherwise you should buy the benchmark instead. But, you can’t buy all 159 equity funds and weight them according to the size.”

What is also significant is that, as the graph above shows, the different FTSE/JSE indices do perform differently. Rule notes that there can be as much as a 6% return variance between them over a 12 month period because of their structural differences.

“When you cap the SWIX, for instance, you get much more exposure to financial services businesses,” says Rule. “You also go overweight on SA Inc. stocks.”

Sector tilts

This means that the choice of benchmark is not just an ad hoc decision, for either active or passive managers. In both cases, they need to be aware of what this means for their portfolios.

Index funds tracking the FTSE/JSE Top 40, for example, will have a 32.4% weighting to resources stocks, and 20.1% to financial services. A fund tracking the SWIX, on the other hand, would only have 19.9% in resources, and 26.7% in financials.

For active managers who are benchmark cognisant, these kinds of differences will have an impact on how they construct their portfolios. Truffle Asset Management, for example, chose the Capped SWIX as the benchmark for the Truffle SCI General Equity Fund. According to portfolio manager Saul Miller, the key reason was that they believed it to be more diversified than other options.

This has however led to a situation where Truffle is currently negative on the prospects for SA Inc. shares but has benchmarked the performance of the fund against an index that gives a higher weighting to this part of the market. For Miller, however, this is not something that they find restrictive.

“Local South African shares do have a higher weighting in the Capped SWIX, but that hasn’t prevented us from having a fairly low exposure,” Miller points out. “We are happy to take significant positions against the benchmark.”

This isn’t necessarily true for all managers, however.

“It has affected us less than it would have affected a fund manager that has very tight tracking error, or who is very close to the benchmark,” Miller explains.

For Rayhaan Joosub, director at Sentio Capital, a good benchmark is one that is diversified, investible and takes out the anomalies of having large foreign stocks in the South African market. It shouldn’t, however, reflect a particular investment view.

“You should make sure that your benchmark is diversified across sector, stock and style exposures, so that, structurally, over time, it performs in a stable way,” Joosub argues. “We think that is what you get from the Capped SWIX. It may have underperformed over the last few years because of its weighting to SA Inc., but when SA Inc. performs again, as we think it probably will, then the Capped SWIX will out-perform again. Ultimately, it will always be less volatile than the ALSI or the SWIX.”