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It was with much interest that I read about the recent revamp of the Straits Times Index (FTSTI) in March 2009 and that the Index would be reviewed and revamped twice a year in March and September to ensure a fair and true representation of stocks listed on the Stock Exchange of Singapore. The latest revision removed 2 property companies - Yanlord Land and Keppel Land; while adding two transport operators - ComfortDelgro and SMRT. Interestingly enough, the reason given was that property was in a slump and that the market capitalization of Yanlord and Keppel Land was lower than that of the 2 transport companies, thus removing them from the index would ensure a better representation as transportation was seen as a more "resilient" industry.
This brings us to the very obvious conclusion that the Index seems to be "revamped" every other time such that the components are switched for other companies. The issue of survivorship bias will certainly be raised - this bias can be explained by the fact that the index continues to persist and climb higher over time not because shares on the whole keep rising, but because the components in the Index are substituted with stronger companies over time, while leaving out the laggard companies which do not perform. This is especially pervasive if you consider the fact that bellweather companies such as Creative used to make up the index until they were dropped due to declining sales and profits.
To cut a long story short, what I am trying to say is that if one uses an Index as a benchmark for stock market performance, one is likely to get results which are highly skewed due to this bias. When weak companies are dropped in favour of good ones, isn't it very obvious even to the layman that the index will continue to rise in future instead of stagnating or even falling behind over time ? Thus, the many articles written about stock markets always returning about 6-8% per annum may not be totally 100% true after all, if we account for this bias and the fact that the index is simply NOT representative from one period to another. For simplicity sake, I will confine my discussion to the Singapore Stock Market as some may point out that the Dow Jones Industrial Index (DJIA) had so many switches in its components since its inception that the Index is almost a totally different animal today than it once was 70 years ago.
This begs the question - how representative is an Index of the broad market and should investors rely on such indices to gauge market sentiment and relative price levels ? Some points to ponder on:-
Read more...[caption id="attachment_1605" align="alignright" width="192" caption="Photo by Anderson Mancini"][/caption]
It was with much interest that I read about the recent revamp of the Straits Times Index (FTSTI) in March 2009 and that the Index would be reviewed and revamped twice a year in March and September to ensure a fair and true representation of stocks listed on the Stock Exchange of Singapore. The latest revision removed 2 property companies - Yanlord Land and Keppel Land; while adding two transport operators - ComfortDelgro and SMRT. Interestingly enough, the reason given was that property was in a slump and that the market capitalization of Yanlord and Keppel Land was lower than that of the 2 transport companies, thus removing them from the index would ensure a better representation as transportation was seen as a more "resilient" industry.
This brings us to the very obvious conclusion that the Index seems to be "revamped" every other time such that the components are switched for other companies. The issue of survivorship bias will certainly be raised - this bias can be explained by the fact that the index continues to persist and climb higher over time not because shares on the whole keep rising, but because the components in the Index are substituted with stronger companies over time, while leaving out the laggard companies which do not perform. This is especially pervasive if you consider the fact that bellweather companies such as Creative used to make up the index until they were dropped due to declining sales and profits.
To cut a long story short, what I am trying to say is that if one uses an Index as a benchmark for stock market performance, one is likely to get results which are highly skewed due to this bias. When weak companies are dropped in favour of good ones, isn't it very obvious even to the layman that the index will continue to rise in future instead of stagnating or even falling behind over time ? Thus, the many articles written about stock markets always returning about 6-8% per annum may not be totally 100% true after all, if we account for this bias and the fact that the index is simply NOT representative from one period to another. For simplicity sake, I will confine my discussion to the Singapore Stock Market as some may point out that the Dow Jones Industrial Index (DJIA) had so many switches in its components since its inception that the Index is almost a totally different animal today than it once was 70 years ago.
This begs the question - how representative is an Index of the broad market and should investors rely on such indices to gauge market sentiment and relative price levels ? Some points to ponder on:-
Read more...
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It was with much interest that I read about the recent revamp of the Straits Times Index (FTSTI) in March 2009 and that the Index would be reviewed and revamped twice a year in March and September to ensure a fair and true representation of stocks listed on the Stock Exchange of Singapore. The latest revision removed 2 property companies - Yanlord Land and Keppel Land; while adding two transport operators - ComfortDelgro and SMRT. Interestingly enough, the reason given was that property was in a slump and that the market capitalization of Yanlord and Keppel Land was lower than that of the 2 transport companies, thus removing them from the index would ensure a better representation as transportation was seen as a more "resilient" industry.
This brings us to the very obvious conclusion that the Index seems to be "revamped" every other time such that the components are switched for other companies. The issue of survivorship bias will certainly be raised - this bias can be explained by the fact that the index continues to persist and climb higher over time not because shares on the whole keep rising, but because the components in the Index are substituted with stronger companies over time, while leaving out the laggard companies which do not perform. This is especially pervasive if you consider the fact that bellweather companies such as Creative used to make up the index until they were dropped due to declining sales and profits.
To cut a long story short, what I am trying to say is that if one uses an Index as a benchmark for stock market performance, one is likely to get results which are highly skewed due to this bias. When weak companies are dropped in favour of good ones, isn't it very obvious even to the layman that the index will continue to rise in future instead of stagnating or even falling behind over time ? Thus, the many articles written about stock markets always returning about 6-8% per annum may not be totally 100% true after all, if we account for this bias and the fact that the index is simply NOT representative from one period to another. For simplicity sake, I will confine my discussion to the Singapore Stock Market as some may point out that the Dow Jones Industrial Index (DJIA) had so many switches in its components since its inception that the Index is almost a totally different animal today than it once was 70 years ago.
This begs the question - how representative is an Index of the broad market and should investors rely on such indices to gauge market sentiment and relative price levels ? Some points to ponder on:-
Read more...
