Fool's Eye View

[ March 9, 2000 ]

Shuffling the Pack

By Stuart Watson (TMFTiger)

Great Titchfield Street, London -- Here we go again. Every time there is a change to any of the stock market indices there is much shaking of heads in Wise circles, pursing of mouths, and mumblings such as "well, of course this makes your standard index tracker far more risky". Does it really? Of is this just another case of knee-jerk throwaway comments made with very little thought?

For starters the majority of index trackers follow the FTSE All-Share. This index comprises of the 800 largest companies on the London stock market. The fact that some companies have moved up into the top 100 does not affect the composition of this index one iota. But what about the FTSE 100 itself?

Eight new companies have entered the FTSE 100 as of today. One is actually a re-entry; Emap (LSE: EMA) had a brief spell in the FTSE 100 last year. Two of the companies, Freeserve (LSE: FRE) and Thus (LSE: THUS) will not be given a full weighting in the index because they are subsidiaries of other companies. The total value of these companies that will be included in the FTSE 100 index calculations is £30b. That seems a lot until you compare it to the total value of all the companies in the index which is around £1,400b. So all the new entrants account for just 2% of the FTSE 100 by value.

In other words they could all go bust, all their share prices could fall to zero, and the FTSE 100 index would fall by just 2%. That hardly seems to represent excessive risk to me, especially when you consider a long-term investment horizon. The risk seems to be on the upside rather than the downside. The combined total value of the new entrants is also around the same as the eleventh most valuable company in the UK, Lloyds TSB (LSE: LLOY).

Most of the confusion seems to arise from a fundamental misunderstanding of what investors are trying to achieve by index tracking. The whole point is to get exposure to all stocks in the market, or a certain part of it. This is explained in more detail, and much more eloquently, in recent Personal Finance articles by TMFJimmyC. There are links to these at the end of this piece.

Other commentaries on this topic bemoan the passing of old industries in favour of the new guard. But surely this is way of the world? The traditional industries of today were the new industries of yesteryear. Surely change is inevitable rather than regrettable? Some chief executives have gone so far as to criticise investors for investing in technology at the expense of their own companies. Perhaps they should concentrate on running their business rather than running their share price. The best businesses will attract investors, although fashion may get in the way for a short time. We all know the stock market is fickle in the extreme. Is it not better to take advantage of this rather than complaining about it?

Related links
• Send your feedback to the Fool's Eye View discussion board
• Press release showing FTSE index changes
• TMFJimmyC on the effect of mega-mergers -- Part 1 & Part 2