How often do you check the S&P/TSX Index? Once a day? Twice? Three times? More than that? Let’s face it. A lot of us closely monitor the S&P/TSX Index’s ups and downs using it as a quick proxy for our own investments. But should we? Is the Toronto Composite Index (S&P/TSX Index) still relevant to investors today?
The Toronto Composite Index (S&P/TSX) is often used as a benchmark for the performance of your investments – but it is really an index? Can we use it historically? Over the next four weeks we’re going to look at this history of the S&P/TSX Index, the numbers behind how it’s broken down, why it’s a closet mutual fund, and if you can use it as a historical ruler.
What is a Composite Index?
Before we look at the S&P/TSX more closely, let’s first look at what a composite index actually is.
A composite index is a grouping of equities that provide a useful statistical measure of overall market or sector performance over time. These indexes are useful for tracking the overall price level changes of an entire market and are thus used as a benchmark you can measure your portfolio against. The goal of a well diversified portfolio is to usually outperform the main composite indexes.
But is the S&P/TSX Index, and other indexes really a useful benchmark to measure the performance of your own portfolio?
History Lesson: The TSE300 Composite Index
First, let’s start with some background info. The TSE300 Composite Index was first implemented in 1977 as a benchmark for the Toronto Stock Exchange. For 25 years, the Index contained 300 companies. The number of companies that were included was set in stone, and the companiesincluded can only be changed once per year at an annual review.
Fast forward to 2002, management of the composite index was contracted out to Standard & Poors from the United States and the TSE300 Composite Index ceased to exist – and the S&P/TSX Composite Index was born. On May 1, 2002 the TSE300 Composite Index ended and a new index, the S&P/TSX Composite Index replaced it.
The Toronto Composite Index Today: The S&P/TSX Index
With this new change came a complete overhaul of the index’s structure, construction and management. New rules were set for a company’s inclusion and exclusion in the index, the number of stock market sectors was reduced from 14 to 10, and the number of companies making up the index became variable and subject to S&P’s discretion.
While the old TSE300 Composite Index was reviewed and adjusted annually, the new S&P TSX Index is reviewed quarterly and can be adjusted at any time based on the direction of the seven members of the S&P/TSX Index committee. And unlike the old TSE300 Composite Index, S&P has complete discretion as to how many companies to include, and how often changes are made.
For example, they can include 269 companies one year, and 204 companies the next year. If they no longer like one of the companies – no problem! – just change it. If S&P thinks that more gold stocks are needed, they simply add them. If tech stocks are no longer performing well – they can just eliminate them (as they did in 2005 and 2011…more on that next week).
With this new set of rules, it kind of sounds like more of an actively managed mutual fund, doesn’t it? Well you’re not wrong there! In other words, you can add (buy), and delete (sell) investments whenever you want.
Hmmm…that doesn’t really sound like an index to me. Next week let’s look at how the index is broken down, and how the rules have changed its composition. Read: The Toronto Composite Index (S&P/TSX): Stats >