All change please
Simon Gergel (pictured), CIO for UK Equities at Allianz Global Investors, highlights the consequences of the recent addition of 29 new companies to the FTSE All Share index…
The changing of index constituents can have some important consequences. Index tracking funds buy the stocks in the index simply because they are there. So, when an index changes they have to buy the new entrants and sell or reduce holdings in those stocks which are ejected or whose weightings are reduced.
Many of the current crop of new index entrants into the FTSE All Share index, like Appliances Online and Poundland, are Initial Public Offerings (IPOs) often being sold by private equity owners. The vendors can choose their timing to coincide with favourable market circumstances, which normally means relatively high valuations. The behaviour of index funds is well understood by the IPO vendors and their advisors and is often a point of discussion during investor briefings. It is very helpful when selling a business, or even when buying one, to know that there is another big potential buyer of your company, irrespective of price. In fact, the higher the valuation of the business, the more index funds will have to buy, ceteris paribus . I am not sure how many investors realise that owning an index fund means having to buy every new issue or new entrant to the FTSE All Share Index.
Indices need to evolve over time to reflect the changing nature of the economy. Just like Dr Who in the eponymous BBC television programme, a process of regeneration is healthy periodically. In 1900 railroad companies accounted for 49% of the value of the top 100 UK companies, whilst industries like television, aerospace, pharmaceuticals and information technology didn’t exist. An index dominated by railway companies clearly wouldn’t represent the investible universe in 2014. Today, companies such as Polypipe, which manufactures plastic piping systems, and Gulf Marine Services, which provides support vessels for the oil industry, are among the new joiners to the FTSE All Share Index.
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