Fidelity Personal Investing
A spokesman and commentator on investments, Tom is responsible for defining and articulating investment strategy for Fidelity’s Personal Investing business. Widely quoted in the national press and appearing regularly on radio and television, Tom is a sought-after expert on markets, investment trends and investment funds. He is a weekly columnist in the Daily Telegraph, and regularly appears on BBC News, Sky and major radio stations. Prior to joining Fidelity, Tom was a financial journalist working for publications including Investors Chronicle, the Independent and the Daily Telegraph.
This article first appeared in the Telegraph.
There’s a sort of cheerless symbolism about last week’s reshuffle of the FTSE stock market indices as the Brexit debate intensifies. Almost certainly this will see the most sovereign of all FTSE 100 companies, Royal Mail , fall out of Britain’s blue-chip index. The gallows humour is underscored by the letters and parcels group’s replacement by Hiscox , an insurance company that has spent heavily on preparing for Brexit, including opening a European subsidiary.
The quarterly rejig of the UK stock market’s principal groupings of shares is a purely mechanical, quantitative review. It ditches companies that have underperformed and replaces them with the best-performers from the lower index. As such it can provide an interesting insight into the broader ebb and flow of the UK market and economy.
The bar for triggering a move in either direction is set quite high. For a company to fall out of the FTSE 100, it must have a market capitalisation (the total value of all its shares) less than that of the company ranked 110th in the UK market. To join the top flight, a FTSE 250 company must be bigger than the 90th ranked business among the blue-chips.
This time around, it looks like both Royal Mail and Hiscox will qualify on those measures when the prices are checked after the market’s close, although strictly speaking Hiscox would replace Royal Mail, and vice versa, simply by dint of being the leading potential replacements from the other index. You can be called on as a substitute even if you wouldn’t qualify on your own merits.
Looking at the bottom ten companies by market size in the FTSE 100 and the largest shares in the mid-cap index, a familiar story emerges. As we head towards the so-called meaningful vote on the Prime Minister’s Brexit withdrawal deal, it is clear that investors have been running for cover from domestically-focused shares and stocking up instead on international-facing exporters and overseas earners.
Run down the list of companies ranked between 90 and 100 in the FTSE 100 and it’s easy to identify the Brexit-related bear case for each stock. EasyJet will be a prime victim of any further sterling weakness as British holiday-makers balk at the cost of a trip to Europe or the US. Direct Line is suffering from the stalling car market. Taylor Wimpey , Rightmove and Berkeley are responding to the weakening housing market. Investors in Severn Trent, and many other utilities for that matter, are looking distinctly uneasy at the prospect of a Corbyn-led Labour government.
Now look at the companies knocking on the door of the FTSE100. Hot on the heels of Hiscox are three engineering groups which are more concerned with what’s happening on the global stage than more parochial issues. Spirax Sarco is an industrial engineering specialist supporting the water industry and reducing emissions; Aveva is focused on the international oil and gas and petrochemicals markets; while Meggitt serves the aerospace, defence and energy sectors.
Should investors care what index a company finds itself in? Well, in the short term, at least, yes they should. That’s because trawling through the reshuffles in recent years uncovers some interesting patterns for the quarterly winners and losers in the period around the change.
When it comes to share price performance, the obvious point to make is that in absolute terms and relative to the rest of the index, the shares that are relegated do so on the back of significant underperformance while those that are promoted do so after a period of strong share price growth. When it comes to reshuffles, however, it really is better to travel than to arrive. A study by Smith’s Corporate Advisory showed that companies promoted to the FTSE 100 had risen on average by over 15% in the two months leading up to reshuffle day, and added another 2% in the short period between the announcement and the change taking effect. In the two months afterwards, however, they fell by 5% on average.
Companies that fell out of the FTSE 100, by contrast, fell by almost 19% in the two months before they got the chop but quickly regained their poise, rising 2% in the interim period before the change actually happened and then moving sideways in the following two months.
One of the reasons that you would think membership of a particular index matters is the way in which passive funds adjust their portfolios on the back of the quarterly changes. This is particularly the case with the FTSE 100 index which is the key benchmark for many UK tracker funds. By definition they can only invest in members of that index and they are forced sellers of relegated stocks.
This helps explain why the negative impact of ejection from an index is so much greater than the positive boost provided by inclusion. In the case of the FTSE 100/FTSE250 threshold, promotion leads to a 6% boost in the average ratio of share price to sales while relegation leads to a 20% fall (comparing the figures two months prior to the reshuffle and two months after).
Last week’s reshuffle is clearly a significant event then but this is not quite the same thing as saying it is a useful one for investors. Markets are pretty good at pricing in predictable influences and the simple arithmetic of the changes to the FTSE indices means that no-one is ever very surprised by the names in the frame on reshuffle day.
The lion’s share of the price and valuation movements have already happened by the time of the announcement. Indeed, there is often a modest reversal of the direction of travel once the good or bad news is confirmed. If you are just finding out that Royal Mail is having a bad time of it while Hiscox is on a roll, you may not have been concentrating.
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The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Investors should note that the views expressed may no longer be current and may have already been acted upon. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser. UKM1118/23039/SSO/0419[/et_pb_text][/et_pb_column][/et_pb_row][/et_pb_section]