Indices change needs rethink

By Peter V O'Brien

Friday 18th October 2002

The Stock Exchange's proposal to report all indices in gross rather than capital terms seems a shortsighted attempt to boost the market's performance at the expense of like-for-like international comparisons.

A draft "proposals for reforming and improving indices" was announced on October 1. It outlined three major changes: eliminating the NZSE40 and NZSE30 indices and replacing them with an improved and expanded NZSE50 free float index; adjusting the construction of the NZSEMC (should that be NZSE small companies?) indices; and reporting all indices in gross rather capital terms.

There is nothing new about adjusting the composition of sharemarket indices, including the number of companies in the calculations, so there is no argument with those parts of the proposal.

The Dow Jones industrial stock price average, for example, was first published in 1897 based on 12 stocks. It was extended to 20 in 1916 and to 30 in 1928.

Companies were taken off the list over the years as the structure of US industry changed. Rising stars replaced them. Similar movements occurred in the broadly based Standard & Poor's 500.

The Nasdaq, weighted to technology stocks, is a relative newcomer to key US indices but is subject to alteration. There were no New Zealand indices until the then NZ United Corporation, another of the late Sir Frank Renouf's innovative financial market creations, created the NZUC index. It became the Barclays index when the UK-based operation acquired NZUC.

All sharemarket indices local, international, exchange-created and based on the analysis of acceptable worldwide financial houses are subject to alteration as life and industry change.

The exchange's statement said the combination of moving the major indices to free float (cutting out major shareholders) and a shift to gross index reporting would better reflect the overall performance of the market, given New Zealand's extraordinarily high dividend payout ratio. That depends on what "performance" one is trying to impress on investors.

The statement reckoned it was valid to compare apples with pears rather than apples. It talked about indices "such as the Australian ASX200, MSCI (Morgan Stanley capital index) and the UK's FTSE100."

The problem was the (possibly careful) avoidance of the main indices used in international market comparisons.

New Zealand's capital indices clearly show an accumulation of dividend payments. Otherwise there would be no explanation for regular share price cuts when stocks go ex-dividend. They rarely rise when a company's shares are declared cum-dividend, after allowance for an increment when a result is above analysts' expectations.

Overseas indices are generally based on capital rather than gross returns. Assume the Dow Jones, Nasdaq, Australian all-ordinaries, Japan's and Hong Kong's indices fall 10% in a given quarter.

The NZSE proposal would see a gross index improvement of a similar percentage in the same period meet the overseas markets' changes. An apples-with-apples comparison could see New Zealand do worse then other markets.

Conversely, New Zealand's performance on the upside could outdo overseas exchanges, even when the gross was ignored in favour of the capital.

There is no extra work for the Stock Exchange in calculating capital indices under the proposed regime than now, so its motives are questionable. The National Business Review regularly compares the local sharemarket's performance with those overseas and will continue such analyses, even if capital indices must be obtained from other sources. They have to be based on apples-with-apples comparisons, or such exercises become meaningless and a sop to New Zealand xenophobia.

There was a suggestion, raised during discussions with brokers about this matter, that the Stock Exchange could approach overseas index compilers to adopt the proposed calculations of indices. If so, the exchange is wished well.

It is likely to get a two-word reply. Exchange chief executive Mark Weldon and his employers need to think again about the proposed abolition of capital indices.

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