Investors in index tracker funds should be alert to the changing nature of the UK indices as increasing numbers of overseas companies list on the London Stock Exchange, according to Jason Hollands, a director at fund managers F&C.
Hollands said the make-up of index tracker funds, once widely perceived as lower risk investments, had changed significantly over the last two decades through a combination of greater concentration at the top end of the market cap spectrum and the globalisation of the market.
“Concentration at the top end of the index is a well established trend with the ten biggest stocks on the FTSE 100 now accounting for a staggering 49.09% of the market and over 75% of the index accounted for by the 29th largest stock. This not only reduces the stock diversification benefits of an index fund but, because these are truly global companies, it also means that it really is too simplistic to regard the FTSE constituents as ‘British blue chip’ companies,” said Hollands.
Indeed, the FTSE 100 index became notably more concentrated last year through one technical adjustment, this being Shell consolidating its dual UK and Dutch listings onto a single London quote. Shell’s share classes alone now account for 8.34% of the FTSE 100. Hollands argues that another wave of change is underway as increasing numbers of overseas companies, particularly in the natural resources sector, enter the FTSE 100.
“Emerging market names like Kazakhstani copper mining company Kazakhmys have made the top 100 and yesterday, the independent FTSE Europe, Middle East and Africa Committee confirmed the promotion of Indian mining company Vedanta Resources to the index,” said Hollands.
“This trend, combined with some of the more traditional ‘blue chip’ names potentially disappearing from quoted markets through mergers and acquisitions or private equity deals such as BAA, shows that the risk characteristics of the indices are constantly changing,” he said.
“London’s success as a global market is clearly a good thing since it widens the opportunities available to investors. However, index fund investors need to be aware that the UK indices now bear little resemblance to the UK economy and old assumptions about the diversification benefits of index funds need to be challenged.”
Hollands concluded that investors wanting exposure to companies with a greater focus on the UK domestic economy might be more inclined to pick funds with a larger weighting in mid and smaller companies.