Department of Business Management, University of Stellenbosch, Private Bag X1, Matieland, 7602, South Africa; PO Box 330, Gallo Manor, 2052, South Africa
Van Heerden, J.D., Department of Business Management, University of Stellenbosch, Private Bag X1, Matieland, 7602, South Africa; Saunderson, S., PO Box 330, Gallo Manor, 2052, South Africa
Portfolio risk is mainly a function of portfolio concentration and covariance between the assets in a portfolio. This study shows that South Africa experiences a high level of market concentration and that assets with large weights in the FTSE/JSE All Share Index (ALSI) have large covariances with each other. Together these two phenomena suggest that a high level of portfolio risk can be expected. Active portfolio managers in South African generally attempt to decrease portfolio concentration by deviating from the benchmark's weighting structure in order to decrease their portfolio risk. The effect of such a portfolio construction process on the measurement of relative performance, where the ALSI is used as the benchmark, was investigated by means of a simulation process. The results indicated that during times when those shares with larger weights in the index perform well, the probability of outperforming the ALSI is very small, while the probability of outperforming the ALSI during times when those same shares perform poorly is very high. These findings suggest that investors need to be educated about the bias regarding relative performance measurement using broad market indices, while alternative or additional methods of performance measurement need to be investigated to minimise this bias.