Why is this important?
“No big deal” you could say, as sector fluctuations allow the index to evolve in line with the economy. However, structural changes over long periods can alter performance characteristics. Furthermore, knowing the sector breakdown of an index is the key to understanding its true economic exposure.
For instance, the financial sector got hit hard during global financial crisis. Its focus in the index contributed to the FTSE 100’s significant drawdown, and its index weight halved in less than four years.
Over the past 30 years the FTSE 100 saw its biggest players expand overseas, while an increasing number of predominantly foreign companies listed on the London Stock Exchange. As a result, more than 70% of total revenues for FTSE 100 companies are now generated overseas. What was once a domestic index can no longer be seen as a proxy for British economic prosperity.
The FTSE 250, meanwhile, is better suited to valuing the UK’s economic performance. It is less globally exposed and more correlated to the fluctuations of the pound. In addition, while the FTSE 100 contains more defensive stocks, the FTSE 250 is made up of more cyclical companies.
Another change that has been occurring in the FTSE 100 is the size of the mega caps included. In 1997 the top 10 companies by market cap covered 55% of the entire index. Since then, the size of the top 10 companies has trended lower, with the current group at 44.3%.
When considering portfolio allocations to UK equities today, many may choose to invest in the FTSE All Share in a bid to ensure a diversified holding. This combines the FTSE 100, the FTSE 250 and smaller companies. Somewhat unbelievably, however, it still has a 35% weight in the top 10 stocks. Investors should question whether this is truly diversified. Adding an additional explicit allocation to the FTSE 250 or small cap stocks could help to diversify UK equity positions.
Many factors influence the FTSE’s movements with some easily forgotten, underrated or overlooked. The allocation to certain sectors, mega cap concentration and regional sales exposure are just some of these factors that investors need to take into account. Ignore the FTSE shuffle at your peril.
To read to full length version of this article, please click here.