Liquid stocks favoured in NZSE-50

By ELLEN READ, markets writer


The Stock Exchange yesterday released final details of the NZSE-50 index, which will replace the NZSE-40 as the official benchmark on March 3.

It will include 50 companies and will be calculated on an adjusted free-float basis - meaning stocks will in general be weighted according to the quantity of their shares freely traded.

The new entrants are: AXA, Calan Healthcare, Capital Properties, Goodman Fielder, Hellaby Holdings, Hallenstein Glassons, Mainfreight, Michael Hill International, National Property Trust, New Zealand Refining Company, Skellmax Industries, Steel & Tube Holdings, Tourism Holdings and Wrightson.

Under the new index, Telecom's weighting increases from 21.37 per cent to 26.96 per cent.

"The thing about Telecom is that it's 100 per cent free float so every single share in Telecom is out there on the market available to be bought and sold," Stock Exchange chief executive Mark Weldon said.

"Over time we would hope that there will be some other large companies or current companies which grow and which take that weighting down. But you don't want to punish Telecom for good performance.

"Some companies have 80 per cent or whatever of their shareholding held up by one particular shareholder or community trust ... Those community trusts would actually be better off selling some of it."

This is because if they sell some of it into free float their weighting in the index will go up, increasing demand for the shares and hence their likely value.

Weldon said the changes bring the headline index into line with international best practice and better reflect the performance of the New Zealand share market.

Behind its design were the principles of greater "investibility", increased breadth and better representation of current market performance.

"[Fund managers with active funds] were worried that should they want to go overweight in some particular stock, it might be hard to buy.

"The [liquidity] criteria means that if it doesn't trade enough for people to buy it, it won't be included in the index," Weldon said.

"The [funds] we've spoken to about this have all been very supportive. Basically it reflects their input so if they don't support it, it would be slightly odd.

"A change of any sort always provokes comment and always creates opportunities to discuss things, which is very healthy and that discussion has led us to create a lot better product."

Andrew Bascand, of fund managers Alliance Capital, said his organisation currently used both the NZSE-40 and another index.

"At this stage, we are reserving judgment on the NZSE-50. We still have some concerns regarding the complexity of the index construction. We want to do a bit more work on that.

"I think it could be quite a big step to persuade trustees of superannuation funds to change the index that we follow."

Some trustees said the Telecom weighting in the NZSE-50 was too large.

BT Funds, which has $500 million under management in New Zealand equities, is also undecided. Chief investment officer Andrew South said he agreed in principle with what the exchange was doing but still had concerns about the liquidity of the bottom 10 stocks.

BT currently uses the NZSE-40 and a variety of other indices.

South said the firm would be working through the details with its clients and was in no hurry to make a decision on which benchmark to follow.

South said criteria they would consider would be: "Is it investible, is it replicable and is it what our clients want?"

While fund managers were important, Weldon was keen to stress the importance of the NZSE-50 for retail investors.

"If you're a retail person and you're investing in a fund then the NZSE-50 is something you can understand. That's what you see and hear about.

"It's a very easy way of communicating to the retail investor what their investment is doing. It makes absolutely no sense for funds to invest in a benchmark which the retail investors won't understand because they're the people who put the money into the funds."

So why the change? The present NZSE-40 is based on the 40 largest companies and has been stuck close to the 2000-points mark for the past 15 years. It is heavily weighted towards a few, very large, mature companies, whose fortunes are tied to the relatively low-growth New Zealand economy.

In contrast, the NZSE-50 broadens the range of companies in the index and because of the weighting adjustments is more indicative of what is traded and available in the market.

While some concerns have been aired over the inclusion of more smaller companies in the benchmark index, the weighting proportion of the bottom 20 companies in the NZSE-50 is the same as the bottom 10 in the NZSE-40. And anyway, small and mid-capitalisation stocks have outperformed their larger counterparts over recent years.

The shift is also being made to a gross index - which includes dividend payouts - from a capital measure. This is important as New Zealand companies pay out some of the highest dividends globally.

The exchange is also introducing the new NZSE Portfolio Index, which limits the dominance of larger companies by capping stocks at 5 per cent of the index.

This addresses one of the key concerns for retail investors worried about the headline index being dominated by one or two large companies.

"We've developed a family of indices that we believe will maximise investibility and better reflect true market performance," said Geoff Brown, NZSE markets development manager.

The four key indices in the family, NZSE-50, NZSE Portfolio, NZSE-10 and NZSE Mid Cap, will provide fund managers with benchmarks that are more accurate, easier to track, and more liquid, he said.

Retail investors will find it easier to measure both market performance and the performance of their individual portfolios, while smaller companies joining the headline index have the opportunity to gain critical market exposure, Brown said.

While the NZSE-50 and Portfolio Index will start on March 3, the launch of the new NZSE-10 and NZSE Mid Cap Index will not be held until May 3 to avoid any price pressure created by the indices' introduction.

Some companies, notably Ports of Auckland, have said the changes have already affected their share prices.

The final NZSE-50 framework includes these changes from earlier drafts:

* A three-tier approach to weighting, where a modified free-float adjustment ensures a more representative composition.

* A change in the treatment of overseas issuers to allow those who have liquidity in this market to have their weighting better reflect the full extent of their participation in the New Zealand economy by percentage revenue earned rather than percentage of shareholders on the register.

* A change in the method for measuring liquidity, which will see the median of each day's trading value divided by the free-float market capitalisation.