ETF: Understanding the CSEW40

ETFs are rebalanced a few times a year to reflect what is going on in the market. Companies that no longer meet the ETF criteria are booted out and rising stars are included. We originally wrote about the CoreShares Equally-Weighted 40 on 3 February 2016, back when it had a different name and the JSE was a different beast.

You might have heard people talk about the Top 40. This index is made up of the 40 largest stocks on the JSE. It is the largest index in South Africa and various ETF products track this index, including the CoreShares Top 40 Equal Weight (CSEW40).

TIP: Not sure what an ETF has to do with an index? We explain that here.

While the CSEW40 ETF also tracks the 40 biggest shares on the JSE, it differs from other Top 40 ETFs in how much of each company is included in the ETF. Normally, a company that is worth more takes up more space in the ETF. A company’s size in the market is determined by multiplying the amount of shares in the market with the company’s share price. This is called market capitalisation. Companies with a bigger market capitalisation make up a bigger part of the ETF.

The CSEW40 ignores the market capitalisation in favour of giving each company equal representation in the ETF. Since there’s 40 shares in the Top 40 index, each share only takes up 2.5% of the ETF.

Both ordinary and equally-weighted Top 40 ETFs invest in Naspers and Richemont. In ETFs weighted by market capitalisation, those two shares make up over 30% of the ETF. If you invest R100, R33 will be put towards Naspers and Richemont, only leaving R67 for the other 38 shares! When those two companies do well, it’s great because your R33 becomes worth more. However, if those companies don’t do well, they can do serious damage to your R100 investment.

By making sure that each company can only take up 2.5% of the ETF, your R100 is split equally across all 40 companies, reducing risk.

TIP: We explain why having money in different companies reduces risk here.

It also means you benefit when smaller companies like Investec and Truworths do well. In a traditional Top 40 investment, those two companies together represent less than 1% of the ETF holdings. Even if they double in size, you probably won’t benefit from the growth. In an equally-weighted ETF, however, those two companies combined represent 5% of the ETF. When they grow, your investment grows.

Weekly expert: Warren Ingram

Warren Ingram from Galileo Capital discusses the benefits and pitfalls of investing in the CSEW40.

What differentiates the CSEW40 ETF?

“The CSEW40 is a great hybrid between a normal (pure) index tracking ETF and a more active ETF such as a RAFI or DIVI investment that has an element of decision-making that can impact the investment positively or negatively. The most valid criticism of index tracking investments is that one or two shares could become so large in your investment that you effectively have no diversification. If you try to address that issue, you need to do so without trying to predict what investments will do well. The CSEW40 strikes a great balance because you get the same shares as a normal Top40 but each share gets the same allocation. This means the costs of the ETF can be limited and there are no “active” decisions that might harm your performance. I also like the fact that you get a larger than normal allocation to the smallest companies in the Top40.”

What limitations should investors be aware of?

“You will miss out on a sustained run in share price of a company because your allocation will always be limited to 2.5%. While this limits some of the upside it means that your money is naturally being reallocated from more expensive shares to better priced ones. The real benefit is proper diversification across 40 shares.”

What type of portfolio would benefit from this holding?

“I think it is ideal for any investor looking for long term capital growth who wants protection from the possibility of a company “blowing up” in your portfolio. You might sacrifice a bit of potential capital growth but your potential downside is more limited than a normal Top40.”

CSEW40 unpacked

ETF name	CoreShares Equal Weight Top40 ETF
ETF JSE code	CSEW40
ETF issuer	CoreShares
Issue date	25 March 2010
ETF TER*	0.39%
ETF benchmark	Equally Weighted Top40 Index
ETF major holdings	British American Tobacco, Bidcorp, Naspers, Firstrand, RMB, Gold Fields, Sasol, Sappi, AngloGold Ashanti, Tiger Brands. View the full list here.
Market cap*	R157 million
Performance (excluding dividends)*	1 year -4.8% 3 year -8.0% 5 year +11.5%
Dividends	2.6%*
What we like	Equal weight reduces concentration of a few large cap stocks giving each stock equal importance in the ETF.