FTSE reshuf­fle is al­ways sig­nif­i­cant but rarely a sur­prise

The Daily Telegraph - Business - - Business Comment - TOM STEVEN­SON

There’s a sort of cheer­less sym­bol­ism about this week’s reshuf­fle of the FTSE stock market in­dices as the Brexit de­bate in­ten­si­fies. This will al­most cer­tainly 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 an EU 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 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 to­mor­row’s market 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 merit.

Look­ing at the bot­tom 10 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 next week’s so-called mean­ing­ful vote on the 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. Air­line easy­Jet will be a prime vic­tim of any fur­ther ster­ling weak­ness as Bri­tish hol­i­day­mak­ers balk at the cost of a trip to Eu­rope. 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 un­easy at the prospect of a Cor­byn-led Labour gov­ern­ment.

Now look at the com­pa­nies knock­ing on the door of the FTSE 100. Hot on the heels of His­cox are three en­gi­neer­ing groups that 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.

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 15pc in the two months lead­ing up to reshuf­fle day, and added an­other 2pc in the short pe­riod be­tween the an­nounce­ment and the change tak­ing ef­fect. In the two months after­wards, how­ever, they fell by 5pc on av­er­age. Com­pa­nies that fell out of the FTSE 100, by con­trast, fell by al­most 19pc in the two months be­fore they got the chop but quickly re­gained their poise, ris­ing 2pc 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. They can only in­vest in mem­bers of that in­dex and 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-FTSE 250 thresh­old, pro­mo­tion leads to a 6pc boost in the av­er­age ra­tio of share price to sales, while rel­e­ga­tion leads to a 20pc fall (com­par­ing fig­ures two months prior to the reshuf­fle and two months af­ter).

This week’s reshuf­fle is clearly a sig­nif­i­cant event, but this is not quite the same thing as say­ing it is use­ful 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.

Tom Steven­son is an in­vest­ment di­rec­tor at Fidelity In­ter­na­tional. The views are his own. He tweets at @tom­steven­son63

‘The bar for trig­ger­ing a move in ei­ther di­rec­tion is set quite high. It looks like both Royal Mail and His­cox will qual­ify’

Newspapers in English

Newspapers from UK

© PressReader. All rights reserved.