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New stock exchange indices designed to cover more bases

Remember the movie Trading Places?

The ASX certainly appears to. In recent months they have made substantial changes to the indices that are usually seen as the benchmarks of trading on the market.

Historically, the All Ordinaries Index has been the primary benchmark of the Australian sharemarket.

The newspapers and radio stations are usually full of comments about the movement of the All Ords.

This movement is then seen as the barometer of the day’s trade and gives us, the mug punters, some form of feeling as to the direction of the market.

The All Ords has generally covered between 85 per cent and 90 per cent of the stockmarket and contained between 280 and 350 securities.

Index fund managers will usually try and replicate the index.

Given that their charter is to do so at low cost, then the presence of a large number of stocks within the index will not allow this to happen.

As a result, for some time now index fund managers have been

placing pressure on the ASX to change their index components and to reduce the number of securities that make up the index.

The ASX launched a series of index reviews culminating in the decision to reduce the emphasis on the All Ordinaries Index and establish several different indices to meet competing needs of different parties.

The new All Ordinaries Index is made up of 500 stocks. As a broad indicator, it is extremely representative of the market.

To make it more relevant to some of the sectors it is also divided into sub-indices as follows:

• ASX 20 (made up of the twenty largest stocks)

• ASX 50 (the fifty largest stocks)

• ASX 100 (the one hundred largest stocks)

• ASX 200 (the two hundred largest stocks)

• ASX 300 (the three hundred largest stocks)

• Small Ordinaries Index (ASX 300 less ASX 100)

The allocation to more benchmarks will allow fund managers to select benchmarks that are more representative of their portfolios.

This also allows investors and financial planners the ability to have a true comparison to determine whether a fund has remained ‘true to labe’ or has drifted away from its core competencies.

It is probably the case that the vast majority of managers will use the ASX 200 and ASX 300 as their benchmarks.

However, there are certain funds that concentrate on the smaller companies as their investment horizon.

For them, the Small Ordinaries Index will be the more relevant.

This means that we can assess our fund manager’s performance at any time against a true benchmark rather than an artificial one.

• Economist Suresh Rajan is a director and proper authority holder with Smith Martis Cork and Rajan – financial planners.

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