Index Education

Why Taking a Local Approach
to Index Construction Matters inCanadaContributor
Michael Orzano, CFA
Senior Director
Global Equity Indicesmichael.orzano@spglobal.com

While nearly everyone in the Canadian investment community has heard of
the S&P/TSX Composite, few are aware of the key methodologicalintricacies that distinguish it from other broad market Canadian equity
benchmarks.
The most notable distinction is that the S&P/TSX Composite is designed
specifically for Canadians (as are all S&P/TSX Indices), while many otherCanadian equity indices, such as the FTSE Canada All Cap Index, aresimply country slices of global benchmarks and, therefore, take theperspective of foreign investors. Why might this matter? Canada hasforeign ownership limits that affect several industries, such as
telecommunications, broadcasting, transportation, and real estate.
Therefore, whether or not these limits are accounted for in the index issignificant.
As an example, Bell Canada (BCE)—the largest Canadiantelecommunications company—was the 10th largest company in theS&P/TSX Composite, with a weight of 2.3%, as of June 28, 2019 (seeExhibit 1). However, foreign investors are restricted from owning more than
one-third of BCE under Canada’s Telecommunications Act. As a result,
BCE’s weight in the FTSE Canada All Cap Index is reduced by two-thirds
from its natural market-cap weighting to roughly 0.75%.
Exhibit 1: Top 10 Constituents
S&P/TSX COMPOSITEFTSE CANADA ALL CAP INDEXCONSTITUENTWEIGHT (%)

CONSTITUENTWEIGHT (%)

Royal Bank of Canada

6.5

Royal Bank of Canada

7.0

Toronto-Dominion Bank

6.1

Toronto-Dominion Bank

6.6

Enbridge Inc

4.2

Enbridge Inc

4.4

Canadian National Railways

3.8Canadian National Railways

4.1

Bank of Nova Scotia Halifax

3.8Bank of Nova Scotia Halifax

4.0

Suncor Energy Inc

2.8

Suncor Energy Inc

3.0

Bank of Montreal

2.8Bank of Montreal

2.9

TC Energy Corporation

2.6

TC Energy Corporation

2.8

Brookfield Asset Management

2.4

Brookfield Asset Management Inc 2.5

BCE Inc

2.3

Manulife Financial

2.2

Total
37.3
Total
39.3
Source: S&P Dow Jones Indices LLC; FTSE Russell. Data as of June 28, 2019. Table is provided forillustrative purposes.

Why Taking a Local Approach to Index Construction Matters in Canada

Canada has foreignownership limits that
affect severalindustries.

Differing definitions ofwhat constitutes a
Canadian company forindex assignment
purposes are also
important to consider.

July 2019

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 theFTSE index relative to the S&P/TSX Composite. Ultimately, the differing
treatments of foreign ownership limits is a key driver of the FTSE CanadaAll Cap Index’s higher concentration in Financials and lower exposure toother sectors such as Communication Services and Real Estate, as
illustrated in Exhibit 2.
Exhibit 2: Comparative Sector Weights (%)
SECTOR

S&P/TSX COMPOSITEFTSE CANADA ALL CAP INDEX

Financials

32.0

34.2

Energy17.1

18.0

Industrials

11.4

11.4

Materials

11.0

11.2

Communication Services

5.6

3.3

Information Technology

5.1

5.4

Utilities

4.3

3.5

Consumer Staples

3.9

4.2

Consumer Discretionary

4.2

4.2

Real Estate

3.4

2.7

Health Care

2.0

1.9

Source: S&P Dow Jones Indices LLC; FTSE Russell; Vanguard. Data as of June 28, 2019. In order tofacilitate apples-to-apples comparison using GICS sectors, weights for the FTSE Canada All Cap Index
are estimated using holdings of Vanguard FTSE All Cap Index ETF. Table is provided for illustrative
purposes.

Differing definitions of what constitutes a Canadian company for index
assignment purposes are also important to consider. For example,
Shopify—the Canadian e-commerce company—was added to theS&P/TSX Composite in March 2017. However, FTSE Russell classified
Shopify as a U.S. company until January 2019, which prevented it frombeing included in the FTSE Canada All Cap Index until earlier this year.
The S&P/TSX
Composite is a broader
representation of theCanadian equity market
relative to the FTSE
Canada All Cap Index.

The S&P/TSX Indices also include companies structured as limited
partnerships (LPs), whereas FTSE Russell’s global equity index
methodology excludes them. Because of this, several Brookfield
Partnerships that own and operate infrastructure, real estate, andrenewable energy assets are excluded from the FTSE Canada All CapIndex. These companies represent a weight of about 1.5% in the S&P/TSX
Composite.
Finally, the S&P/TSX Composite is a broader representation of theCanadian equity market relative to the FTSE Canada All Cap Index. As ofJune 28, 2019, the S&P/TSX Composite included 239 constituents,representing a total index market cap of nearly CAD 2.3 trillion, while theFTSE Canada All Cap Index included 205 components and a 6% smaller
aggregate index market cap of CAD 2.15 trillion. This disparity is partially

INDEX EDUCATION | Equity 101

2Why Taking a Local Approach to Index Construction Matters in CanadaJuly 2019

driven by the inclusion of LPs, but it is largely due to the relatively more
inclusive size and liquidity requirements of the S&P/TSX Composite.
Exhibit 3: Index Characteristics
CHARACTERISTIC

S&P/TSX COMPOSITEFTSE CANADA ALL CAP INDEX

239

205

2,292.34

2,152.52

Largest149.44150.20

Smallest

0.56

0.30

Average

9.59

10.50

Median3.00

3.37

Number of Constituents

Methodology
differences havecontributed tomeaningfulperformancedifferences over time.

Float-Adjusted Market Cap(CAD Billions)

Source: S&P Dow Jones Indices LLC; FTSE Russell. Data as of June 28, 2019. Table is provided forillustrative purposes.

While the returns of the two indices have historically tracked fairly closely,
the methodology differences discussed have contributed to meaningfulperformance differences over time. As depicted in Exhibit 4, the 3.87%
total return of the S&P/TSX Composite was nearly 1% greater than theFTSE Canada All Cap Index over the trailing 12-month period. Over thepast 10 years, the S&P/TSX Composite has outperformed by 42 bps peryear with slightly lower volatility.
Exhibit 4: Risk/Return Comparison
PERIOD

S&P/TSX COMPOSITEFTSE CANADA ALL CAP INDEX

1-Year

3.87

2.97

3-Year

8.39

8.11

5-Year

4.67

4.29

10-Year

7.79

7.37

1-Year

14.20

14.18

3-Year

9.15

9.24

5-Year

9.04

9.22

10-Year

9.88

10.13

1-Year

0.27

0.21

3-Year

0.92

0.88

5-Year0.52

0.47

10-Year

0.79

0.73

ANNUALIZED RETURNS (%)

STANDARD DEVIATION (%)

The S&P/TSX
Composite hasoutperformed by 42 bps
per year with slightly
lower volatility.

RISK-ADJUSTED RETURN

Source: S&P Dow Jones Indices LLC; FTSE Russell. Data as of June 28, 2019. Calculations arebased on gross total return index levels in CAD. Past performance is no guarantee of future results.
Table is provided for illustrative purposes.

CONCLUSION
In summary, it is important to look under the hood and understand thedesign features of seemingly similar benchmarks. Because of its
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Why Taking a Local Approach to Index Construction Matters in Canada

July 2019

comprehensive nature and Canadian-centric design features, the S&P/TSX
Composite may more fully and accurately reflect the investment opportunity
set available to Canadian investors in comparison to other market indices.

The S&P/TSX
Composite may more
fully and accuratelyreflect the opportunity
set available toCanadian investors
than other marketindices.

As a final note, you may often see the S&P/TSX Capped Composite cited,
given that it underlies several index-based products, and wonder how it
differs from the headline S&P/TSX Composite. The term “capped” refers to
the fact that the methodology includes a 10% cap—or limit—on the weightof any single stock. The capped version of the index was introduced backin 2000, when Nortel Networks grew to become so large that it represented
nearly one-third of the weight of the S&P/TSX Composite. However, Nortel
soon shrank and the S&P/TSX Composite and S&P/TSX Capped
Composite have been nearly identical since 2001, as no company has helda weight in excess of 10%.

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4Why Taking a Local Approach to Index Construction Matters in Canada

July 2019

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