An introduction to Stock Market Indices

‘The Stock market’ talk is all over from print to electronic media and even the web. But what does it mean when people say that "the market performed well today?" or “the market is down today?” What is "the market" that everyone is referring to anyway? As it appears to be, when most people talk about "the market," they are actually referring to an index. With the growing importance of the stock market in our society, the All Share Price Index (ASPI) and the Milanka Price Index (MPI) of the Colombo Stock Exchange (CSE) have become familiar terms especially for the investing community in their everyday vocabulary.

Charles Dow created the first and, consequently, most widely known as the Dow Jones index back in May of 1896. At that time, it contained 12 of the largest public companies in the U.S. Today, the Dow Jones Industrial Average (DJIA) contains 30 of the largest and most influential companies in the U.S. Like Dow Jones, the Nasdaq, S&P 500, Nikkei, and Sensex, are widely known market indices in the world. In the Sri Lankan context the well known indices would be the All Share Price index, Milanka Price index (MPI) and MBSL Midcap index.

For investors, indices give the direction of the entire market. They use indices to track the performance of the stock market. Ideally, a change in the price of an index represents an exactly proportional change in the stocks included in the index. The ASPI is one of the principal stock indices of the CSE and it measures the movement of share prices of all listed companies which is as of date 259 companies from 20 different business sectors, based on market capitalization.

In this article, we would be discussing more about the different kinds of indices in Sri Lanka, their importance and computation methodologies.

Purpose of Stock Market Indices The most basic purpose is to provide a measure to understand the direction or the movements of the market as a whole. An increase in the index indicates a rising market and decrease indicates a falling market. Market indices enable us to calculate market return. It represents the rate of return earned by investing in a portfolio that impersonates the market portfolio. Market return and risk are typically used as primary benchmarks to judge investment performance of a portfolio. Technical analysts try to predict future price movements by looking at the behavior of past price trends.

What's the difference between Time Weighted Return and Internal ...

PortfolioCenter provides two main performance calculations: Internal Rate of Return (IRR) and Time-Weighted Rate of Return (TWR).  What’s the difference?

Internal Rate of Return (IRR) is the single rate of return at which the beginning market value plus additions grows to equal the ending market value minus withdrawals.

IRR is computed through a process of trial and error (Base Estimation Method) where you “guess” what number makes everything you put into the investment equal everything you took out.  Then you try that guess into the equation and, depending on the results, keep refining your guess until the equation works.  In reality, returns may have bounced wildly up and down during the time period, but IRR is the slope of a hypothetical straight line between the beginning and ending value

The timing and size of cash and securities moving in and out of the account greatly influence IRR.  The larger the amount, the more it affects the return.  The IRR should not be compared to a market index (which has no cash flows) or for measuring the performance of a manager, because IRR is affected by events over which the manager has no control, such as the client making large deposits or withdrawals.

T ime-weighted Rate of Return (TWR) measures the manager.

TWR links together a series of returns on smaller sub-periods or “intervals” through a geometric formula.  The intervals remove the impact of deposits and withdrawals and the number of total dollars.  TWR measures the investment performance of the average dollar in the portfolio, and more accurately reflects the manager’s choices.

Bottom line:

Accurate performance returns depend on putting accurate data into PortfolioCenter.  Consider outsourcing to an expert.

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