Page 155 - Profile's Unit Trusts & Collective Investments - March 2025

Classification of CISs

Dow Jones Industrial Average (DJIA)
The DJIA is an index of approximately 30 “blue-chip” US stocks. At over 100 years, it is the
oldest continuing US market index. It is called an “average” because it was originally
computed by adding up stock prices and dividing by the number of stocks. (The very first
average price of industrial stocks, on 26 May 1896, was 40.94.) The methodology remains the
same today, but the divisor has been changed to preserve historical continuity. The DJIA is the
best-known market indicator in the world, partly because it is old enough that many generations of
investors have become accustomed to quoting it, and partly because the US stock market is the
globe’s biggest.
Overseas, there are many index funds which track the DJIA.

In the UK and the US a standard feature of index funds is their substantially reduced annual
management fees, which adds to the performance of these funds over time. In South Africa, many
passive funds now cost investors less than 0.5% per annum in ongoing fees and some are available
for as little as 0.10% VAT included. The largest funds in the US have total ongoing charges as low as
0.04% and 0.015% per annum and Morningstar reports that the weighted average fee for all passive
funds is 0.36% as of 2023.
It must be stressed that index funds cannot be compared with one another unless they seek to
follow the same index. The best index fund is not the one which performs the best in terms of
returns, but the one with the least tracking error – the one that tracks its chosen index the closest.
Index funds around the world track a wide (and increasingly diverse) range of indices, from
narrow regional indices to global indices and smart indices (see below). In South Africa the most
tracked index is the FTSE/JSE Top40. This index is sometimes skewed in favour mining and
commodity stock, which historically have constituted a disproportionate percentage of the JSE.
More than 240 rand-denominated index funds are available to investors in South Africa. They
track everything from property, financials and industrials to specific overseas markets such as
Japan, Europe and the US. Many of these are also ETFs (exchange traded funds).
Smart Indices
Until the early 2000s, most indices around the world were either simple averages (see Dow
Jones box) or, more usually, market-cap weighted. Index funds and ETFs that track indices
weighted by market cap are tacitly endorsing the idea that the market price of a share is a good
valuation of the company. The basic assumption of a market-cap-weighted index is that the market
values shares correctly; the larger the market cap of a stock, therefore, the bigger its influence
within the index.
Smart indices (also known as smart beta indices) take the view that the share price is not
necessarily the best reflection of a company’s value. The Rafi, for example, is an index created by
US-based Research Affiliates using fundamental valuation criteria – metrics such as sales,
cashflow, book value and dividends. This can change not only the index constituents but also the
weighting of shares within the index. In 2024, for example, the Rafi40 included four shares not in
the Top40, and the latter included five shares not in the Rafi40.
Beta refers to the return of ‘the market’, and market-cap weighted indices are the accepted
proxy for ‘the market’. The term ‘smart beta’ derives from the idea that there are other ways to
represent ‘the market’ and better ways to construct indices. Market-cap-weighted indices
automatically overweight over-valued stocks and underweight under-valued stocks; by focussing
on other factors, smart beta developers believe they can create cleverer indices designed to
outperform conventional indices.
More than 10 collective investments in South Africa track smart indices. The underlying
indices include the Rafi, the SWIX and the DIVI (see box at the top of the next page).

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