INDEXTSI: OSPTX vs NDEXSWX: SMI | CSSMI vs XIC
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Efficient allocation of capital is crucial for managing a portfolio effectively. This report analyzes whether the Swiss market Index is a better investment, compared to the S&P TSX Composite Index, Canada's biggest stock index.
Proponents of both indices present qualitative factors as to why one is better than the other; however, data-derived insights are most valuable for definitive answers. This report utilizes more than 60 years of data, 3 decades of data per index, for definitive answers. Hypothesis testing has been conducted in this report: the report utilizes a pooled comparison test to analyze returns and an F test to analyze risk.
So, what does the data reveal?
First, we must consider the long-term growth rate (geometric mean) for the last 3 decades (1988-2021):
1. The long-term growth rate (geometric mean) of the Swiss Market Index is 6.5% p.a. CHF (8.15%, factoring in USD long-term depreciation against CHF of 1.6% p.a.)
2. The long-term growth rate (geometric mean) of S&P/TSX is 5.7% p.a. CAD (USD/CAD rate has fluctuated in the last 3 decades, of course; however, the exchange rate in late 2021 is very much identical to 1988, February (in the range of 1.22XX) (The Canadian dollar, nonetheless, has depreciated at a yearly rate of 1.01% against the Swiss Franc in the last 3 decades)
The analysis reveals that the monthly returns of the SMI are statistically identical to the returns of the TSX; the risk, as measured by variance, of the returns of the two is also similar, statistically. The data analysis reveals that one cannot be considered better than the other, considering the performance of the last 3.4 decades. See also: Why do all financial assets correlatively fall in a market crash
The geometric mean of the SMI is lower when gauged in CHF; however, when factoring in the exchange rate, CHF/USD or CHF/CAD, SMI's long-term growth rate is higher than that of S&P/TSX, when measured in USD or CAD, due to the yearly appreciation of CHF against the USD, and CAD.
In conclusion, data analysis reveals that the long-term returns of SMI (yearly growth rate), as measured by geometric mean, are comparable to TSX for the last 34 years. However, adjusted for currency fluctuations, the SMI has a superior return compared to TSX due to depreciation of CAD against CHF. The monthly variance of returns, the risk, of the two is also comparable and statistically equivalent.
For risk-adjusted returns of indices analyzed in this report, i.e., returns offered per unit risk & other diversification concerns, see our report: Which stock indices/index-based ETFs provide the best risk-adjusted returns
Further Critical factors
"The SMI does provide good international exposure through stable names such as Nestlé, Lonza group, Novartis, Roche holdings, etcetera. Its international exposure, thus, is arguably better than that of the S&PTSX, and it is more Canada-centric and more financial, energy, and materials sector heavy.
Many investors and analysts see limited long-term capital growth or firm-specific growth potential in the energy sector, and the finance sector is usually considered as a high beta sector, exposing investors to higher levels of upside or downside risk as the markets fluctuate.
The two sectors with the most weight in the TSX (finance and energy), in a post-pandemic world of low credit demand, and fervent and dynamic shift towards renewables, aren't the most ideal investments.
Naturally, Canadian investors, as an alternative, maybe more drawn towards S&P 500. However, it must be understood that with a possibility of political turmoil or tensions, internally, and with international adversaries like China, North Korea, or Iran impacting the major North American Indices, S&P 500 or Nasdaq composite Index may be more exposed and sensitive to geopolitical and internal risks compared to the Swiss index.
Thus, as an alternative, allocation in SMI, through iShares SMI-ETF, does not seem illogical. Circumspection is very important, primarily proactively. If more than 35% of an investor's portfolio is allocated to North American indices, prudence would command lowering it to no more than 25%, and the SMI can play an important role there. Doing so would reduce exposure to geopolitical risks and other North America-specific idiosyncratic risks.
For example, an investor with 35% or more of her portfolio allocated to North American Indices, should consider diversifying due to a build-up of a cluster of external and internal possibilities that can impact the North American Indices negatively.
While it is true that turmoil in, or associated with North America, should substantially impact the SMI as well, as the SMI declined 53.42%, peak to troughs, in the 2008 financial crisis, and 21.6% in the 2020 market crash, compared to Nasdaq's similar decline of 52.1 for the 2008 financial crisis, and about 20% for the 2020 market crash, groups such as Nestle, Swatch, Lonza, Novartis, Roche, etcetera, are growing in multiple emerging economies.
Their growth and future prospects of growth in emerging economies is far superior compared to top names in S&PTSX. Other than a few exciting names such as Shopify Inc., Thomson Reuters Corporation, and Restaurant Brands International Inc., TSX lacks a concentration of names that may be classified as 'capable of significant growth in the emerging markets.,' as companies expanding in those markets have better capital growth prospects for their equity.
Presently, it is worth noting that the US is the biggest export market of Switzerland.
Long-term, while the sensitivity of SMI to international financial fluctuations should remain present, the reliance of its constituents on North America should continue to decline. Thus, it does make sense to have some exposure to SMI.
However, exposure should be limited to below 15% in the overall portfolio, ideally around 10%, with the broader assumption being that SMI is a slightly 'mellower' version of a top global index, such as the S&P 500, with its constituents demonstrating healthy growth in emerging markets. The most prominent growth opportunity in the S&PTSX is the financial sector, arguably; still, we cannot expect exponential growth in this sector long-term.
While SMI does include financial heavyweights, the financial sector makes up less than 15% of the index.
Another point worth understanding is that while the two indices in question have statistically same returns and risk, the Swiss franc has appreciated at a long-term rate of about 1% p.a. (geometric mean), against CAD; thus, the returns of the Swiss Index when converted back (yearly) into CAD, gained 1% currency appreciation (as investment in the Swiss Index is CHF denominated). Without conversion, the currency difference, combined with the monthly returns, would compound, further increasing the returns of the Canadian investor compared to the Canadian TSX.
All in all, the Swiss Market Index does present a good diversification opportunity for Canadian investors and other international investors; its risk is comparable to the premier Canadian Index, and it has names that are further penetrating emerging markets and have a healthy foothold in developed markets as well.
Allocation of 10% of the portfolio in the Swiss Market index, at the very maximum, would benefit an investor by providing a higher degree of international diversification, that too through solid names, reducing the concentration of North American names in the portfolio" (see also: S&P500VsSMI).
Data and calculations
Pooled variance test is conducted as:
H0: µ1 -µ2 = 0, vs H1: µ1 -µ2 ≠ 0
The mean returns of Index 1 minus Index 2 (comparison) are analyzed for equivalence.
F test has been conducted as:
H0: σ1 = σ2, vs H1: σ1 ≠ σ2
The variance of the returns of Index 1 is compared to the variance of the returns of Index 2 (comparison) to assess equivalence.
Pooled variance test
Two sample t-test (pooled variance), using T distribution (DF=798.0000) (two-tailed) (validation)
1. H0 hypothesis Since p-value > α, H0 is accepted. The average of SwissIndex's population is considered to be equal to the average of the TorontoStockIndex’s population. In other words, the difference between the average of the two populations is not big enough to be statistically significant. 2. P-value p-value equals 0.764290, ( p(x≤T) = 0.617855 ). This means that if we would reject H0, the chance of type I error (rejecting a correct H0) would be too high: 0.7643 (76.43%). The larger the p-value the more it supports H0. 3. The statistics The test statistic T equals 0.299955, is in the 98% critical value accepted range: [-2.3310 : 2.3310]. x1-x2=0.00090, is in the 98% accepted range: [-0.007000 : 0.001668]. The statistic S' equals 0.00300 4. Effect size The observed standardized effect size is small (0.021). That indicates that the magnitude of the difference between the average and average is small.
F test for variances, using F distribution (dfnum=399,dfdenom=399) (two-tailed) (validation)
1. H0 hypothesis Since p-value > α, H0 is accepted. The sample standard deviation (S) of SwissIndex's population is considered to be equal to the sample standard deviation (S) of the TorontoStockIndex’s population. In other words, the difference between the sample standard deviation (S) of the two populations is not big enough to be statistically significant. 2. P-value The p-value equals 0.06482, ( p(x≤F) = 0.9676 ). It means that the chance of type I error, rejecting a correct H0, is too high: 0.06482 (6.48%). The larger the p-value the more it supports H0. 3. The statistics The test statistic F equals 1.2034, which is in the 98% region of acceptance: [0.7919 : 1.2628]. S1/S2=1.1, is in the 98% region of acceptance: [0.8899 : 1.1237]. The 98% confidence interval of σ12/σ22 is: [0.9529 , 1.5196].