Today the FTSE100, 250 and smaller companies index have a slightly different look about them because of the quarterly promotion/relegation battle that goes on which can see each index change over time. Without going into the calculation that determines who gets promoted and relegated, these changes should be noted and if necessary acted upon by investors and traders.
For long term buy and hold investors it can be a big negative if the company that you hold gets relegated. Usually, the relegation is known well in advance, so it is possible to act before the change actually happens. Whether you act will depend on how you see the prospects for the company going forward. A few quarters back hedge fund manager Man Group was one of those relegated from the FTSE100 to the 250 index and since then its share price has continued to fall. It had been in freefall for some time prior to its relegation, so the writing had been on the wall that the company was facing difficulties.
On the other hand, if you hold a company that is promoted often the share price will rise as the bigger buyers come in to add to their positions. This probably is more the case with smaller companies promoted to the FTSE250, but also companies promoted to the FTSE100 might see some price rise as FTSE 100 funds will look to buy.
So, what changed today?
In the FTSE100 we have the promotion of energy services company Wood Group and manufacturing investor Melrose. Going the other way are a couple of financial companies ICAP and Ashmore.
Promoted to the FTSE250 are Playtech, Pace, Supergroup, Unite Group and Workshop Group.
Relegated to the small cap index are Aquarius Platinum, Avocet Mining, Gem Diamonds, Cape and JP Morgan Asian Investment Trusts.
However, any one looking to take advantage of these changes need to be careful as often the share price of the promoted companies will have had a good run before they go up. For example, John Wood Group is up about 45% in the last year. It's a good company, but there is a lot of good news already in the price.
The other point to note about these changes is the general effect over time this may have on the index. Back in the boom days of the tech bubble lots of IT companies were in the FTSE100, which goes some way to explaining why at the time the FTSE was merrily going up towards 7000 back in 2000. Most of those FTSE tech bubble companies are now in the lower indices. Some no longer exist, going bust with the tech bubble. In the last few years, financial companies have dropped out, while back in 2008, much of the rise in the FTSE100 during the credit bubble years was due to mining and commodity plays rising on the back of the money liquidity boom and the hopes of China growth and the new emerging boom economies.
The lesson here is that these indices change over time, they are not static and fixed and it is why buy and hold investors need to be aware that even though those in the financial industry like to point out the advantages of long term buy and hold strategies, the company you hold can come and go very quickly. After all, claims of an x% annual rise in an index is no good to you if the companies that you hold are in decline, have fallen out of favour and find themselves relegated with the small fish.
As an example, back in 2002 HMV was floated and joined the FTSE250, it's share price reached the dizzy heights of 282p in 2005. That price is dizzy because today the company languishes with the small caps at a share price of 2.80p. Shareholders who hung on have been wiped out.
From the point of view of each index however, poor performing companies are relegated, got rid of, they are no longer a lag on the overall price of the index. After all, if the FTSE100 was simply a static index, all those high flying tech companies back in 2000 and dodgy financial and mining stocks in 2008 would have taken it down to the sort of crash price that permabears constantly dream about. Such changes are rarely mentioned, but for the overall performance of an index we need to be aware of them.
So, if you like to buy a broad cross section of an index, you are probably better off just buying a tracker fund than individual companies, especially if you don't want to be an active investor. If you prefer more action and like to be involved, just remember that over time indices change and look out for the quarterly promotion/relegation battle.
http://uk.reuters.com/article/2012/09/12/markets-stocks-ftse-rejig-idUKL5E8KCIU320120912
http://www.ft.com/cms/s/0/dbe51bd2-f33d-11e1-9ca6-00144feabdc0.html
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