Page 158 - Profile's Unit Trusts and Collective Investments 2021 issue 2

CHAPTER 8

Dow Jones Industrial Average (DJIA)
The DJIA is an index of approximately 30 “blue-chip” US stocks. At over 100 years, it is the
oldest continuing US market index. It is called an “average” because it was originally
computed by adding up stock prices and dividing by the number of stocks. (The very first
average price of industrial stocks, on 26 May 1896, was 40.94.) The methodology remains the
same today, but the divisor has been changed to preserve historical continuity. The DJIA is the
best-known market indicator in the world, partly because it is old enough that many generations of
investors have become accustomed to quoting it, and partly because the US stock market is the
globe’s biggest.
Overseas, there are many index funds which track the DJIA.

When they were first introduced, the annual management fees of funds of funds tended to
be more expensive than other types of unit trusts because there was a double layer of costs.
However, it is more often the case that “in-house” FoFs usually dispense with the second
layer of costs and some of the more competitive unit trust management companies absorb
the “second layer costs”.
Sometimes in-house funds of funds are launched to help brokers and retail investors who
have a small lump sum (below R50 000) to get exposure to a wide range of funds.
Funds of funds are required to report in the same way as other unit trusts. Investors can
therefore pick up and track the switches between funds.
Index (Tracker) Funds
Index funds, also known as “passive funds” or “tracker funds”, are mathematically driven
collective investment schemes that are designed to match the performance of a particular index.
The mandate of these funds is to track the performance of a benchmark index by buying the shares
in that index at their respective weightings. The index fund is therefore a physical replication of the
constituents of the index, and will “track” the movements of the index, rising as the index rises
and falling when the index falls, hence the term “tracker fund”.
The rationale behind these funds becomes clearer when investors understand that, in most
developed markets, it is difficult to outperform the index. Often quoted figures state that only 25%
of US fund managers outperform the S&P 500 at any one time.
Different market conditions favour different investment styles, and index funds can be expected
to be in and out of fashion depending mainly on how active fund managers are doing. However, in
developed markets passive funds have become a major force in the industry, with some estimates
suggesting that these funds now comprise nearly half of total industry assets in the USA.
In the UK and the US a standard feature of index funds is their substantially reduced annual
management fees, which adds to the performance of these funds over time. In South Africa, at least
half a dozen passive funds now cost investors less than 0.5% per annum in ongoing fees (all charges
included). The largest funds in the USA have total ongoing charges as low as 0.04% per annum.
It must be stressed that index funds cannot be compared with one another unless they seek to
follow the same index. The best index fund is not the one which performs the best in terms of
returns, but the one with the least tracking error – the one that tracks its chosen index the closest.
An overall index fund exposes the investor to middle-of-the-range risk.
Index funds around the world track a wide (and increasingly diverse) range of indices, from
narrow regional indices to global indices and smart indices (see below). In South Africa the most
tracked index is the FTSE/JSE Top40. This index is sometimes skewed in favour mining and
commodity stock, which historically have constituted a disproportionate percentage of the JSE.
Over 150 rand-denominated index funds are available to investors in South Africa. They track
everything from property, financials and industrials to specific overseas markets such as Japan,
Europe and the USA. Many of these are also ETFs (exchange traded funds).

156 Profile’s Unit Trusts & Collective Investments — Understanding Unit Trusts