Monday was an important day for the NZX because it passed all responsibilities for the maintenance, calculation and dissemination of its indices to S&P Dow Jones Indices.

The new arrangement will facilitate the development and commercialisation of these indices, which measure the performance of New Zealand’s equity and fixed income markets.

The NZX indices are now called the S&P/NZX indices. This is consistent with the Australian Stock Exchange which has a similar arrangement with S&P Dow Jones Indices. Its indices are called the S&P/ASX indices.

Indices are widely quoted and play an important role in determining how we measure the performance of sharemarkets versus other forms of investment. Investors, both private and institutional, also compare their performances against indices.

Sir Frank established the country’s first merchant bank in 1960, New Zealand United Corporation, and the index was renamed the NZUC Index.

The index was calculated monthly at first but became weekly in February 1962 and daily in June 1966.

The index was calculated manually and published a few hours after the market closed. It was a painstaking exercise involving a large number of calculations. Needless to say it was not unusual for the index to be revised in subsequent days.

The NZX, which comprised physical trading floors in Auckland, Wellington, Christchurch and Dunedin, was a much more relaxed organisation in those days.

For example, the last index calculation in 1967 was on December 16 and the next on January 9. The following summer there was no index calculation between December 14 and January 13.

The original NZUC Index, which was capital only, contained 40 of the stock exchange’s largest listed companies.

Capital indices do not include dividends. Thus a $1 stock that goes ex a 10c dividend – and its share price falls to 92c – will have a negative impact on an index.

By contrast, the same situation would have a positive influence on a gross or accumulation index because they include dividends.

Under a gross index scenario when a $1 stock goes ex a 10c dividend – and the share price falls to 92c – an investor’s total holding increases from $1 to $1.02 (92c share price plus 10c dividend).

In December 1983, Barclays Bank acquired a major shareholding in New Zealand United Corporation from Sir Frank. The merchant bank changed its name to Barclays Bank New Zealand and the NZUC Index became the Barclays Index.

The Barclays Index was a household name in the mid-1980s as it surged from 1284 at the end of 1983 to an all time high of 3969 on Friday, September 18, 1987.

During this period the Barclays Index, excluding any dividends, soared a staggering 209 per cent in just 45 months.

Barclays Bank New Zealand was a victim of the October 1987 crash and the Barclays Index was transferred to the NZX in 1991 and renamed the NZSE Top 40 Index.

The NZX introduced gross indices in 1986 but they received little media or investor attention as the focus remained on the benchmark Barclay Index, which was capital only.

This was partly because most of the world’s best known indices, including the Dow Jones Industrial Average, FTSE-100 Index, Tokyo’s Nikkei 225 Index and Hong Kong’s Hang Seng Index are capital indices.

However, the NZX’s emphasis shifted from capital to gross indices when Mark Weldon was appointed chief executive in 2002.

On March 3, 2003, Weldon replaced the stock exchange’s benchmark capital index with the new benchmark NZX50 Gross Index. The base for the new gross index was 1880.85, the same level as the capital index closed on Friday, February 28, 2003.

There are four main index measurement systems:

1. Capital indices – where dividends are not taken into account.

2. Dividends added back – where distributions are added back to a share price when a company goes ex dividend.

3. Actual dividends are reinvested – this assumes that all distributions are reinvested across the index at closing prices on the dividend ex date.

4. Gross dividends are reinvested – this assumes that the dividend and the imputation credits attached are reinvested across the index at closing prices on the dividend ex date.

On March 3, 2003, the widely used NZX benchmark index switched from the first to the fourth methodology.

This looked like an attempt to boost the image of the NZX because it had delivered a compounded capital return of only 1 per cent during the 1990s.

However, there was strong opposition to the new methodology from investors because it is extremely difficult to outperform the “gross dividends reinvested” measure, particularly over the longer term. This is because of the compounding impact of reinvesting the actual dividend, plus the imputation credits attached, over an extended period.

The NZX relented and changed its methodology from the fourth to the third methodology.

The latter approach now applies to the benchmark S&P/NZX50 Gross Index.

There is a huge difference, in terms of performance, between the capital and gross approach.

For example, since February 28, 2003, the S&P/NZX50 Capital Index has risen by 55.8 per cent whereas the S&P/NZX50 Gross Index has surged 205.5 per cent.

This is a significant difference, particularly as the two indices contain the same companies with uniform weightings.

Most investors, particularly the investment management industry, aim to outperform the 205.5 per cent figure rather than the 55.8 per cent.

A number of observations can be made about the accompanying table which shows the annual performance of the Capital Index since January 1957:

• There have been 36 positive years and 23 negative ones;

• The best years were 1983 with a return of 116.8 per cent and 1986 with a 99.2 per cent return;

• The worst years were 1987, which had a negative 48.5 per cent performance, and 1990 with minus 39.7 per cent.

The 1980s was clearly the best decade for the NZX as it had a compounded return of 18.8 per cent a year even though the market experienced a huge crash in 1987 that destroyed investor confidence.

The rush into residential property was clearly influenced by the very poor performance of the NZX during the 1990s and 2000s.

In that period, it delivered annual compounded capital returns of only 1 per cent and a negative 0.3 per cent in each decade respectively.

The capital index has delivered a compounded return of 6 per cent a year – before any dividends – over the 58-plus years covered by this review.

In addition, the average dividend yield of index companies has mostly been between 4 per cent and 7 per cent over this period, although it was in excess of 12 per cent at the end of 1983.

It was just 2.5 per cent before the 1987 crash.

The current net dividend yield, before taking into account imputation credits, is 4.8 per cent.

On the basis of a capital return of 6 per cent a year and dividend yields between 4 per cent and 7 per cent, the NZX has delivered annual compounded returns between 10 per cent and 13 per cent, with a mid-point figure of 11.5 per cent, since January 1957.

This is a very respectable return over an extended period although there have been a high number of ups and downs along the way.


Brian Gaynor

Portfolio Manager