Global events in the past few weeks have proved that no one has a crystal ball. An active fund manager who had taken a positive view on financial shares could not have predicted the collapse of some of the world’s most famous financial names.
This is a strong argument for index tracking, which gives a well-diversified portfolio of shares across all sectors at a low cost.
The one problem with traditional indices is that they are market cap-based. In other words the larger the company, the higher the percentage it makes on the investment. This means more expensive shares tend to have higher weightings, while undervalued shares tend to have lower weightings. But value investing, which invests in companies that are undervalued by the market and tend to be cheaper, has been shown to outperform in the long term. Satrix RAFI 40, the new offering from Satrix, blends both the benefits of index tracking with value investing.
The Satrix RAFI 40 is based on the FTSE/JSE RAFI 40 index, which identifies companies that are fundamentally undervalued by the market. The index selects 40 major JSE companies that are undervalued and weights them accordingly.
“The Satrix RAFI 40 will, by seeking undervalued companies, look to provide a ‘value lift’ as the market is likely to rerate the undervalued companies in the RAFI 40 in due course,” said Mike Brown, general manager of Satrix.
The relative outperformance of investing in undervalued companies has been proved by backtracking the data provided by the FTSE/JSE in the past eight years — July 2000 to July 2008 — during which the FTSE/JSE RAFI 40 total return index has outperformed the most widely followed Top 40 index by an average of 8,3% a year. “Even if the Top 40 index is calculated on a total return basis, the RAFI 40 still outperforms by 4,8% per annum,” said Brown.
The FTSE/JSE analyses company data over five years and focuses on sales, cash flow, book value and dividends. The index is reviewed and adjusted once a year in February. Companies that no longer qualify after value assessment according to the RFV methodology will be dropped from the index and replaced by a stock that is undervalued. In this way the RAFI methodology always seeks value offering companies.
This product is a total return product and therefore capitalises all income and dividends into the price. Brown said retaining income in the portfolio should enable the overall capital value of the portfolio to compound over time. Because income will be invested immediately, it will largely eradicate the time delay between the declaration of dividends and their reinvestment.
Brown said this so-called “cash drag” is typically the main cause of tracking error in index tracking products. Satrix will issue tax statements each year specifying the capital and dividend portions so that capital gains tax is not paid on the income portion of the total return when selling the investment.
How to invest
The Satrix RAFI 40 will list on October 16 2008. Investors can submit applications to their stockbrokers, to Standard Online (the participating stockbroker) or to the Satrix Investment Plan before October 6 2008. Minimum subscriptions are R1 000 and in multiples of R1 000. After listing, investors can buy the securities through their broker as per normal shares or invest through the Satrix Investment Plan, which also caters for monthly debit orders with a minimum of R300 a month.
Costs for investing through the Investment Plan are 0,1% upfront for debit orders or lump sums. Debit orders have an additional fee of R3,50. There is an annual administration fee of 1% plus the underlying Satrix RAFI management fee, which is a maximum of 0,7%.