The performance of the local Australian equity market is represented by a market-capitalisation weighted index like the ASX200 or All Ords Index. An individual company’s weighting in the index is determined by their total market value, with the largest companies by size (market-capitalisation) therefore having the largest representation in the index. An important consequence of this type of index methodology is that both an individual company’s relative share price performance and weighting in the index determine its contribution to the overall market performance.

In Australia the market-capitalisation based indexes are very concentrated, with the big four retail bank constituents and resulting banking sector representing circa 31% of the ASX 200 Index at the time of writing. The performances of big companies like the banks are critical in driving the index performance, while other better performing, but much smaller companies, may make little contribution. This is clearly illustrated by looking at individual company contributions to the index’s return of 2.1% for December 2014:

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For active managers, like Elston, who do not build portfolios based on reproduction of index weightings; most investor portfolios will show significant short term variation from the market-capitalisation index performance. This raises a question: Is measuring portfolio performance relative to a highly concentrated market-capitalisation based index, a rigorous method of judging manager performance?

If you would like to find out more call 1300 ELSTON or click here to have an Elston Adviser contact you.