The S&P/TSX Composite is widely known, but few recognize the intricacies of its underlying methodology
The decision to include a company within a certain index or portfolio can be fraught with complications. But when it comes to one popular Canadian equity index, that complexity can go to a deeper level thanks to local considerations.
“While nearly everyone in the Canadian investment community has heard of the S&P/TSX Composite, few are aware of the key methodological intricacies that distinguish it from other broad market Canadian equity benchmarks,” wrote Michael Orzano, senior director for Global Equity Indices at S&P Dow Jones Indices.
Like all S&P/TSX indices, the S&P/TSX Composite is designed specifically for Canadians. Orzano explained that other Canadian equity indices simply take the perspective of foreign investors since they are just single-country slices of global benchmarks — and that has considerable implications.
“Canada has foreign ownership limits that affect several industries, such as telecommunications, broadcasting, transportation, and real estate,” he said. “So, whether or not these limits are accounted for in the index is significant.”
He cited the example of Bell Canada, the tenth largest company in the S&P/TSX Composite with a weight of 2.3% as of June 28. But Canada’s Telecommunications act prevents foreign investors from owning more than one third of BCE, its weight in the FTSE Canada All Cap Index is reduced by two thirds from its natural market cap weighting.
“Real estate investment trusts are also subject to a 49% ownership limit, which results in the weight of the Real Estate sector being reduced in the FTSE index relative to the S&P/TSX Composite,” Orzano added. The differences in foreign ownership limits, he explained, is a primary driver of the FTSE Canada All Cap Index’s higher concentration in financial companies and lower exposure to other sectors such as communication services and real estate.
Also important are the differing definitions of what constitute a Canadian company for index assignment purposes. While Shopify, the Canadian e-commerce company, has been part of the S&P/TSX Composite since March 2017, it wasn’t until January this year — before that, FTSE Russell had classified it as a US company — that it was added to the FTSE Canada All Cap Index.
“Finally, the S&P/TSX Composite is a broader representation of the Canadian equity market relative to the FTSE Canada All Cap Index,” Orzano said. As of June 28, the S&P/TSX Composite had 239 constituents with a total index market cap of almost $2.3 trillion; the FTSE Canada All Cap Index, meanwhile, had just 205 components and a 6% smaller aggregate index market cap of $2.15 trillion.
“While the returns of the two indices have historically tracked fairly closely, the methodology differences discussed have contributed to meaningful performance differences over time,” Orzano wrote. The total return of the S&P/TSX Composite over the trailing 12-month period was reported at 3.87%, nearly 1% greater than the FTSE Canada All Cap Index. The S&P/TSX index has also outperformed its FTSE counterpart by 42 basis points per year with slightly lower volatility over the past decade.
