Useful Insight for Your Investment Choices

“Stocks closed with losses as last year’s selling pressures poured over into a busy first trading week of 2023. The ______ index has dropped by X.X%, while the technology-heavy _______ index fell 0.8%. The _________ index capped the session just below breakeven.”

Most financial reporting starts with the proclamation of the current level or changes to the major indices of various major markets, before moving on to more specific stories. How much do you know about those index numbers?

More and more individuals are taking on greater involvement with their investment portfolios, which requires an increasing need to continue to improve one’s financial literacy and investment knowledge. To understand and successfully use information being provided by the indices in investment decisions and analyses, it is important to know how they are calculated and how adjustments to the indices are made when companies that make up the index (referred to as constituents) change or when different kinds of corporate-actions occur, such as: stock splits, spin-offs, merger or acquisitions, etc.

While many mainstream media and online websites provide an up to minute movement of the index numbers and how the “markets are doing,” not many provide the background needed to understand the magic behind the numbers.

On a monthly basis, Statistics Canada releases the Financial Market Statistics from the Toronto Stock Exchange. This data set contains the monthly recorded number from 11 different Standard & Poor’s (S&P) indices from Toronto Stock Exchange (TSX).

S&P is a leading index provider and data source of independent credit ratings. S&P originated in the United States in 1941 following the merger of two financial data publications, Henry Varnum Poor’s publication on railroad prices (dating back to 1860) and The Standard Statistics Bureau (founded in 1906). S&P’s most famous index is S&P 500 index, which tracks the performance of the 500 largest public companies in the U.S.

Broadly speaking, an index is an indicator or measurement of something. In investing, an index tracks the performance of a group of assets or a basket of securities, such as a list of publicly traded companies and their stock prices.

The data contained in the Financial Market Statistics from the Toronto Stock Exchange includes monthly data from: the S&P/TSX Composite Index (High, Low, and Close numbers), the S&P/TSX 60 Index, and ten of the S&P/TSX Capped Sector Indices.

Defining Composite, Sector, Capped, and Index Divisor

Before getting into how these indices are calculated, it is important to know the definitions of some general terms, such as: Composite, Sector, Capped and Index Divisor.

A composite index is a statistical tool that groups together many different equities, securities, or indexes to create a “representation” of the overall market (or sector) performance. Normally, the constituents of a composite index are combined in a standard way so that large amounts of data can be presented easily. Examples of some well-known composite indices are: the Nasdaq Composite Index (Nasdaq), Standard & Poor’s 500 Index (S&P 500), and Dow Jones Industrial Average Index (DOW).

Sector indices create a “representation” and summary performance data for specific sectors (or industries). This allows investors to compare and contrast a particular company’s stock performance against the sector’s performance. The specific sectors (or industries) are determined by the Global Industry Classification Standard (GICS). GICS was developed in 1999 by Morgan Stanley Capital International (MSCI) and Standard & Poor’s (S&P) and is used by the global financial community. GICS consists of 11 sectors, 24 industry groups, 69 industries and 158 sub-industries which all major public companies are categorized.

An index that is capped has restrictions on the upper weight limit any particular company can have in calculating the index even if a company capitalization (value of the company calculated as current stock price times the number of shares) naturally carries a greater weight in the market.

The important element in understanding indices is the index divisor. This is a figure used to standardize the value of a market index and ensures that particular corporate-actions do not significantly alter the index. A simple weighted index could be the market (capitalization) value of all available shares for companies in the index. If an investor was tracking this index, in terms of market value in dollars, it may prove to be quite challenging especially, if the market values contained ten or more digits (e.g. S&P 500 market value is roughly $11.8 trillion). However, scaling the market value down, it becomes easier for the investor to read and use. Scaling is done by dividing the market value by an index divisor. For example suppose a market value is $51,000,000 divided by 100,000 would give an index value of 510. If the market value increased to $51,250,000 then the new index value would be 512.5 (or 0.49% increase).

However, when companies are swapped in and out the index number, the company being introduced may have a different number of shares and a different share price than the company that it replaces which would alter the market value and in return alter the index number. It is vitally important that the index number remains consistent and only tracks the market value change that occurs due to price, therefore the index divisor is regularly adjusted. Any changes in shares outstanding, capital actions, addition or deletion of stocks to the index should not change the level of the index and the index number provides a continuous “representation” measure of market valuation. If the market closes at 1250 and one stock is replaced by another after the market closes, the index should open at 1250 the next morning if all opening prices are the same as the previous day’s closing prices.

There are a variety of different methods used in calculating indices. For example Standard & Poor indices have as many as five different categories of indices, based on different methods of calculation. They are: Capitalization Weighted Indices, Equal Weighted Indices, Modified Market Capitalization Weighted Indices, Attribute Weighted Indices, Leverage and Inverse Indices, and Fund Strategy Indices.

Three Methods of Calculation

The 14 indices reported on by Statistics Canada in Financial Market Statistics from the Toronto Stock Exchange use the following three different methods of calculation:

The first method is used to create Capitalized-weighted indices (also known as value-weighted or market cap weighted). These indices are calculated as:

INDEX Number=i Pi * Qi * IWF Index Divisor or 1250 =$11.8 trillion$9.4 billion

Suppose the value of the portfolio was $11.8 trillion, derived by multiplying the current stock price by the number of shares available to investors [Price (Pi) x Number of Shares (Qi) x IWF], and dividing it by the index divisor of $9.4 billion, then the index number would be 1250.

Note the number of shares available to investors does not include shares that are closely held, that is, where a company’s common shares are predominantly owned by one individual owner or by a small group of controlling stockholders, it also does not include, in some cases, shares owned by foreigners. To reduce the quantity of shares calculated in the index, the total number of shares is multiplied by what is called the stock’s float factor (IWF), in other words, the percentage of available shares. When an index is calculated with IWF it is referred to as being float adjusted. Some well known examples of capitalized-weighted indices are: S&P 500, S&P Global 1200, FTSE’s indices, and Russell indices.

The second method of calculation is used to create a Modified market cap (capitalization) weighted index. This type of index is where the constituents have a user-defined weight in the index. Typically, this method of calculation is used for indices where some constituents are restricted to a maximum weight (such as with “capped” indices). The excess weight is distributed proportionally among the remaining index constituents. As stock prices move, the weights will shift and the modified market cap weighted index requires to be rebalanced from time to time to re-establish proper weighting.

Calculating the modified market cap weighted index is similar to market cap weighted indices, with the exception of the constituents’ market values are re-defined to be values that achieve the user-defined weighting at each rebalancing.

INDEX Number=Aggregate Adjusted Market ValueIndex Divisor

Aggregate Adjusted Market Value = [Pi * Qi * IWFi * ExRatei * AWFi]

INDEX Divisor=Market Value after AdjustmentsMarket Value before Adjustments x Divisor before Adjustments

Where ExRate is the exchange rate (when applicable) and AWF is the adjustment factor of stock assigned at each index rebalancing date. The AWF factor adjusts the market capitalization for all index constituents to achieve the user-defined weight, while maintaining the total market value of the overall index.

The third method of calculation is used to produce Equal weighted Indices. Equal weighted indices are indices in which every stock has the same weight in the index. As stock prices move, the weights will shift and exact equality is lost. Therefore, an equal weighted index must be rebalanced from time to time to re-establish the proper weighting.

To calculate an equal weighted index, the market capitalization for each stock used in the calculation of the index is redefined so that each index constituent has an equal weight in the index at each rebalancing date. In addition to being the product of the stock price, the stock’s shares outstanding and the stock’s float factor (IWF) and the exchange rate (where applicable), along with the additional weight factor (AWF). The AWF of each stock is assigned at each index rebalancing date to make all index constituents’ modified market capitalizations equal (and therefore, equal weight), while maintaining the total market value of the overall index.

INDEX Number=Aggregate Adjusted Market ValueIndex Divisor

Aggregate Adjusted Market Value = [Pi * Qi * IWFi * ExRatei * AWFi]

INDEX Divisor=Market Value after AdjustmentsMarket Value before Adjustments

Financial Market Statistics from 11 Indices

Having a basic understanding of the above three methods of calculation, we can now easily look at the 11 indices reported by Statistics Canada monthly in Financial Market Statistics from the Toronto Stock Exchange.

The S&P/TSX Composite Index (SPTSX) is the main stock market index for the Toronto Stock Exchange (TSX) that represents a diverse range of industries and sectors, it serves as the headline index and the primary gauge for the Canadian equity market:
Launched January 1, 1977;
Calculated using the float-adjusted market cap weighted method;
Rebalanced quarterly (March, June, September, December);
236 constituents with total market capitalization of approximately $3.09 trillion (as of December 31, 2022);
Largest constituent weight 6.3%;
Sector breakdown: Financials 30.8%, Energy 18.1%, Industries 13.3%, Materials 12%, Information Technology 5.7%, Communication Services 4.9%, Utilities 4.4%, Consumer Staples 4.2%, Consumer Discretionary 3.7%, Real Estate 2.6%, and Healthcare 0.4%.

The S&P/TSX 60 Index (TSX60) is an index designed to “represent” the leading companies in leading industries. It covers the large-cap market segment of the Canadian equity market. The TSX 60 Index represents the Canadian component of Standard & Poor’s flagship S&P Global 1200 Index:
Launched December 31, 1998;
Calculated using the float-adjusted market cap weighted method;
Rebalanced quarterly (March, June, September, December);
60 constituents with a total market capitalization of approximately $2.4 trillion dollars (as of December 31, 2022);
Largest constituent’s weight 7.9%;
Sector breakdown: Financials 35.1%, Energy 18.3%, Industries 12%, Materials 10.6%, Information Technology 5.9%, Communication Services 5.8%, Consumer Staples 4.5%, Consumer Discretionary 3.7%, Utilities 3.4%, and Real Estate 0.6%.

The S&P/TSX Consumer Discretionary Spending Index (TTCD) is an index that tracks companies classified as having goods and services that are considered non-essential by consumers, but desirable if their available income is sufficient to purchase them. Examples of consumer discretionary products can include durable goods, high-end apparel, entertainment, leisure activities, and automobiles:
Launched December 10, 1998;
Calculated using the float-adjusted market cap weighted method;
Rebalanced quarterly (March, June, September, and December);
15 constituents with an adjusted market capitalization of approximately $109.6 billion dollars (as of December 31, 2022);
Largest constituent weight is 24.8%;
Some well known companies included in the TTCD are: Dollarama (DOL), Canadian Tire Corporation CTC.A), and Pet Valu (PET).

The S&P/TSX Capped Consumer Staples Index (TTCS) is an index that tracks the consumer staples sector and includes companies that provide goods and services that people use on a daily basis, like food, clothing, or other personal products:
Launched on May 1, 2002;
Calculated using modified market cap weighted method;
Rebalanced quarterly (March, June, September, and December);
11 constituents with a total market capitalization of just over $173.8 billion dollars (as of December 31, 2022);
The largest constituent weight is 24.7%;
The TTCD includes companies such as: Loblaws Companies Limited (L), George Weston Limited (WN), and Maple Leaf Foods Inc. (MFI).

The S&P/TSX Capped Energy Index (TTEN) is an index that tracks the energy sector and includes companies that are engaged in the exploration, production, and distribution of energy resources such as natural gas, and renewable energy sources:
Launched on October 2, 2000;
Calculated using the modified market cap weighted method;
Rebalanced quarterly (March, June, September, and December);
29 constituents with a total market capitalization of approximately $335.1 billion dollars (as of December 31, 2022);
The largest constituent weight is 24.7%;
The TTEN consists of companies such as: Canadian Natural Resources (CNQ), Suncor Energy Inc. (SU), and Cenovus Energy Inc. (CVE).

The S&P/TSX Capped Financials Index (TTFS) is an index that tracks the financial sector and includes companies that are involved in a wide range of financial activities, including banking, insurance, asset management, and other financial services:
Launched on October 2, 2000;
Calculated using the modified market cap weighted method;
Rebalanced quarterly (March, June, September, and December);
29 constituents with a total market capitalization of approximately $908.9 billion dollars (as of December 31, 2022);
The largest constituent weight is 20.5%;
The TTFS consists of companies such as: Royal Bank of Canada (RY), The Toronto-Dominion Bank (TO), and Bank of Montreal (BMO).

The S&P/TSX Equal Weight Industrials Index (TTIN) is an index that tracks the industrial sector and includes companies that are involved in the production and distribution of goods and services used in a variety of industries, such as manufacturing, transportation, and construction:
Launched on November 19, 2012;
Calculated using the equal weighted method;
Rebalanced semi-annually (March and September);
27 constituents with a total market capitalization of approximately $444.7 billion dollars (as of December 31, 2022);
The largest constituent weight is 6%;
The TTIN consists of companies such as: Canadian National Railway Company (CNR), Canadian Pacific Railway (CP), and Ritchie Brothers Auctioneers Incorporated (RBA).

The S&P/TSX Capped Information Technology Index (TTTK) is an index that tracks the information technology (IT) sector and includes companies involved in a wide range of IT activities, such as the development and distribution of software, the production of computer hardware, and the provision of telecommunications services.
TTTK was launched on October 2, 2000;
Calculated using the modified market cap weighted method;
Rebalanced quarterly (March, June, September, and December);
27 constituents with a total market capitalization of just over $172.8 billion dollars (as of December 31, 2022);
The largest constituent weight is 26.1%;
The TTTK consists of companies such as: Shopify Inc. (SHOP), Constellation Software Inc. (CSU), and Blackberry Limited (BB).

The S&P/TSX Capped Materials Index (TTMT) is an index that tracks the materials sector and includes companies involved in the extraction and processing of metals and minerals, the production of forestry products, and the manufacture of chemicals and other materials:
Launched on May 1, 2002;
Calculated using modified market cap weighted method;
Rebalanced quarterly (March, June, September, and December);
50 constituents with a total market capitalization of approximately $365.5 billion dollars (as of December 31, 2022);
The largest constituent weight is 15.2%;
The TTMT consists of companies such as: Nutrien Ltd. (NTR), Barrick Gold Corp (ABX), and Teck Resources (TECK.B).

The S&P/TSX Composite Index Communication Services (Sector) Index (TTTS) is an index that tracks the communications services sector and includes companies involved in activities, such as, the provision of telecommunications services, the production of media content, and the operation of internet and social media platforms:
Launched on May 1, 2002;
Calculated using the float-adjusted market cap weighted method;
Rebalanced quarterly (March, June, September, and December);
6 constituents with a total market capitalization of approximately $142.1 billion dollars (as of December 31, 2022);
The largest constituent weight is 39.5%;
The TTTS consists of companies such as: Telus Corporation (T), Rogers Communications Inc. (RCI.B), and Shaw Communications Inc (SJR.B).

The S&P/TSX Capped Utilities Index (TTUT) is an index that tracks the utilities sector and includes companies involved in activities, such as, the generation, transmission, and distribution of electricity, the production and distribution of natural gas, and the provision of water and sewage services.
Launched in May 1, 2002;
Calculated using the modified market cap weighted method;
Rebalanced quarterly (March, June, September, and December);
16 constituents with a total Market Capitalization of just over $144.5 billion dollars (as of December 31, 2022);
The largest constituent weight is 20.9%;
The TTUT consists of companies such as: Fortis Inc. (FTS), Hydro One Limited (H), and AltaGas Limited (ALA).

With over 70 different indices available to investors on the Toronto Stock Exchange, knowing the above three methods used to calculate indices provides a good start for understanding how indices may or may not assist in your investment strategy. Whether your investment strategy is based on investing in a single company, multiple companies, or whether you self-manage or have a professionally-managed portfolio, knowledge of indices, what they track, and how they are calculated can provide a useful insight for your investment choices.