Page 159 - Profile's Unit Trusts and Collective Investments 2021 issue 2

Classification of CISs

GIVI, SWIX and DIVI
The Global Intrinsic Value Indices are produced by US-based S&P Dow Jones. The
GIVIs, like the Rafi and eRafi (see Smart Indices section), use criteria other than market
cap to determine index constituents and weighting (although GIVI does not consider
small-caps, so there is in effect a small market-cap component). The GIVIs, however, define ‘value’
very differently to Rafi. The GIVI consists of fifty shares selected on the basis of volatility (only the
least volatile shares are included), liquidity (shares with turnover below a certain threshold are
excluded), and book value. The GIVI rules also stipulate that no single constituent may ever make
up more than 10% of the index.
The SWIX (shareholder weighted) indices contain the same constituents as the market-cap
indices but weight the constituents according to free float (ie, the number of shares freely available
in the local market). This reduces the weightings within the index of big dual-listed shares like British
American Tobacco and BHP Billiton.
In the name of a passive fund, ‘DIVI’ usually refers to the JSE’s Dividend Plus Index, which
contains the thirty shares with the highest forecast dividend yields. The index is weighted by
dividends, which means that the DIVI is effectively a value style index.

Smart Indices
Until the early 2000s, most indices around the world were either simple averages (see Dow
Jones box) or, more usually, market-cap weighted. Index funds and ETFs that track indices
weighted by market cap are tacitly endorsing the idea that the market price of a share is a good
valuation of the company. The basic assumption of a market-cap-weighted index is that the market
values shares correctly; the larger the market cap of a stock, therefore, the bigger its influence
within the index.
Smart indices (also known as smart beta indices) take the view that the share price is not
necessarily the best reflection of a company’s value. The Rafi, for example, is an index created by
US-based Research Affiliates using fundamental valuation criteria – metrics such as sales,
cashflow, book value and dividends. This can change not only the index constituents but also the
weighting of shares within the index. In late 2016, for example, the Rafi40 included eight shares
not in the Top40, and the latter included ten shares not in the Rafi40. The weighting of Naspers in
the Top40 was six times that of the Rafi40, and the weighting of the mining sector in the Rafi40
was double that of the Top40, to quote just two examples.
Beta refers to the return of ‘the market’, and market-cap weighted indices are the accepted
proxy for ‘the market’. The term ‘smart beta’ derives from the idea that there are other ways to
represent ‘the market’ and better ways to construct indices. Market-cap-weighted indices
automatically overweight over-valued stocks and underweight under-valued stocks; by focussing
on other factors, smart beta developers believe they can create cleverer indices designed to
outperform conventional indices.
Over twenty collective investments in South Africa track smart indices. The underlying indices
include the Rafi, the GIVI, the SWIX and the DIVI (see box at the top of this page).
Feeder Funds
A feeder fund is one of several types of conduit funds that act as channels for investments into
larger funds.
The principal (or receiving fund) is sometimes called an umbrella fund or “master” fund.
This tiered structure is also sometimes used by hedge funds to create critical mass by pooling
investment capital from different sources.
Returns from the master fund, such as dividends and capital gains, are distributed to the feeder
funds on a pro-rata basis.
In the SA environment, some feeder funds have a one-to-one relationship with the master
fund. In these cases the feeder fund is created in order to have a rand-denominated investment
vehicle in South Africa while the underlying assets are held overseas and priced in their respective
base currencies.

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