FTSE 100 reshuffle

Graham Smith

Graham Smith - Market Commentator

Following an exuberant start to the year then sharp falls in early February, the UK stock market appears to have hit a patch of relative calm. That’s understandable if you believe this week’s slew of domestic political and corporate developments probably don’t change anything all that much.

The Labour Party’s backing of a customs union with Europe after Brexit may heap pressure on the UK government to soften its stance, but there’s nothing much new in that. With time fast running out for negotiations, the need for politicians to find workable solutions to safeguard the economy and jobs was only ever likely to become more pressing.  

Equally, a temporary price cap on energy bills for customers with standard variable and default tariffs was signalled at last year’s general election and should come as no surprise to investors in energy firms.

Indeed, shares in the UK’s largest listed energy providers Centrica and SSE were barely moved by Monday’s government announcement, having both suffered sharp falls late last year on the publishing of draft legislation1. It’s also unclear what effect a move likely to reduce competition in the energy market will have on average prices over time.

Markets have a great tendency to absorb current information quickly then move straight to making an assessment about the future. So share prices tend to move ahead of actual events, making meaningful readjustments only if consensus expectations are not met.

In the UK, this has meant factoring in Brexit and associated political and economic uncertainties leaving the UK market looking inexpensive compared to its international peers. Sectors exposed principally to Britain’s domestic economy have been out of favour, but overseas earners have become unfairly entangled in the negative sentiment too.

According to MSCI, UK companies trade on a multiple of about 14.4 times the earnings they’re expected to make this year, compared with 17 times for the world generally. The UK market’s 3.8% dividend yield looks attractive on an absolute and relative basis, with world stocks yielding about 2.2%2.

Another round of corporate results and updates this week fitted largely with what we already know. For example, Associated British Foods confirmed its low-cost Primark clothing stores remain in fine fettle, on a high street where many traditional, mid-market retailers are finding it hard to compete3.

Housing-related stocks found the going more difficult. The builders merchant Travis Perkins and the London-focused estate agent Foxtons both reported profit falls in 2017 and spoke of challenging market conditions4.

This week’s quarterly reshuffle of the companies that make up FTSE 100 Index reflects known-about change. That’s because stocks are routinely promoted to or ejected from this index on the basis of how well they have fared against others in the past.

The demotion of commercial property giant Hammerson follows the company’s bid for Intu Properties, which expands its reach into struggling shopping malls. Conversely, Royal Mail’s promotion back to the FTSE 100 reflects, in part, optimism about rising parcel volumes due to online shopping.

However, active fund managers have the opportunity to invest in emerging winners long before they attain the dizzy heights of FTSE 100 membership. Remember today’s new entrants have already outperformed, their share prices having taken into account to some degree current and future business successes.

On the other hand, a fund that invests purely in the index fails to capture these outperforming stocks until they have become part of the index. It is also required to retain an exposure to losing companies until they have dragged behind far enough to have their shares ejected, or worse, they fail altogether.

While these factors might seem to favour an active investment strategy, selecting the right active fund is critical. Even if a majority of active funds outperform an index, it’s nearly always the case that a significant number of others are also trailing behind.

This is where Fidelity Select 50 list, which seeks to identify the best funds with robust and repeatable investment processes, aims to help.  The list currently includes UK equity funds employing very different investment styles.

The JOHCM UK Equity Income Fund emphasises stocks expected to yield more than the market average in the year ahead and has a contrarian investment style aimed at finding value. Here, alongside the big FTSE 100 dividend payers Royal Dutch Shell, BP and HSBC, you’ll currently find large positions in the insurer Aviva and the broadcaster ITV.

On the other hand, the LF Lindsell Train UK Equity Fund has a strong bias to growth companies. It currently has a considerable exposure to UK companies benefiting from the rising demand in emerging markets for branded goods, via large holdings in the luxury goods company Burberry, global beverages producer Diageo and consumer products group Unilever.

We interview Nick Train, manager of the LF Lindsell Train UK Equity Fund in the latest episode of MoneyTalk


1 Bloomberg, 27.02.18 and the Telegraph, 04.10.17
2 MSCI United Kingdom Index, 31.02.18
3 AB Foods, 26.02.18
4 Foxtons, 28.02.18

Important Information

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