The application of fundamental indexing to the South African equity market for the period 1996 to 2009

ABSTRACT

Over the years the norm in the investment industry has been to use market capitalization-weighted indices as benchmarks to measure investment performance. However, market capitalization-weighted indices, such as the FTSE/JSE All Share Index (ALSI), create a natural return drag because of the overweighting of overvalued stocks and vice versa.

On the other hand, fundamental indexing weights stocks based on their economic footprint in the market rather than their market capitalization. The fundamental indexing approach uses four metrics, namely sales, book values, dividends and cash flows to calculate this footprint.

The fundamental index concept delivered very good results when applied to the South African stock market. The South African Fundamental Index outperformed the ALSI by 4,7% p.a. during the period 1996 to 2009. This return was achieved with a risk profile similar to that of the ALSI. This index also had similar turnover rates relative to the ALSI.