All about investment

The FTSE 100 index is used as the benchmark for measuring the strength of the UK stockmarket, and some commentators have argued it has a natural bias to outperform the wider FT All Share index, because it tends to promote to its ranks those stocks which are in the ascendancy and remove others that are falling away.

From time to time the index can appear to be affected by a high weighting given to one particular sector, and it could be argued that at present the mining sector (Anglo American, Antofagasta, BHP Billiton, Kazakhmys, Lonmin, Rio Tinto, Vedanta Resources and Xstrata) has undue influence. Stockmarket traders will recall the famous and dramatic year of 2000 when the FTSE 100 list contained such passing technology stars such as Energis, Bookham Technology, Arm Holdings, Freeserve, Baltimore and Psion – great memories!

Given the increasing use of tracker funds, it is important to look at where sector and stock monies are flowing, because these fund managers have to match whatever is in each benchmark index, so new entries and deletions are worth researching by CFD traders before they happen.

The purpose of this paper is not to discuss whether or not it is worth buying or selling a new constituent, as significant academic studies (with some conflicting results) have been made on this subject. It is more a summary of what changes to look for in assessing possible constituent moves, and there are various ways that the FTSE 100 list can be changed.

Quarterly reviews

This is the most common way for changes to be lagged. The committee that oversees the various FTSE indices meets quarterly on the Wednesday after the first Friday in March, June, September and December. Constituent changes are then implemented on the next trading day following the expiry of the LIFFE futures and options contracts, which normally takes place on the third Friday of the same month. The rankings of constituents by value are calculated using close of business prices on the day before the review, and companies must have a minimum trading record of 20 days at the review.

A company is promoted to the FTSE 100 index if it rises to 90th or above when the eligible securities are ranked by market value

It is relegated if it falls to 111th or below.

Where there are more companies qualify to be inserted in an index than those qualifying to be deleted, the current lowest ranking constituents are relegated to ensure there are always 100 companies in the index. If there are more qualifiers for relegation, the highest ranking companies that are not already in the index will be promoted to match the numbers.

The six highest ranking non-constituents of the FTSE 100 Index at the time of the periodic review are known as the reserve list, and are used in the event that one or more constituents are deleted from the FTSE 100 during the period up to the next quarterly review.

Fast Entry

The second way a company can enter the FTSE 100 index is if it is a new issue and larger than 1% of the full market capitalisation of the FTSE All-Share Index. In this case it will normally be included in the top 100 after close on the first day of trading, and the lowest ranking constituent is removed.

Eligibility of equities

Only the eligible quoted equity capital is included in the calculation of its market capitalisation, so if a company has two or more classes of equity, significant and liquid secondary lines are included in the calculation of the market capitalisation of the company, based on the market price of that secondary line.

The committee can decide if a secondary line is to be priced separately if its full market capitalisation (before the application of any investibility weightings) is more than 25% of the full market capitalisation. If the full market capitalisation of a secondary line, which is already a constituent of the Index, falls below 20% of the company's main line at the quarterly review, the secondary line will be deleted from the index, but this happens rarely.

Convertible preference shares and loan stocks are excluded until converted.

Rights or other issues

If a company issues shares, partly or nil paid, and the call dates are already determined and known, the market capitalisation is adjusted so as to include all such calls, which would reflect the total fully shares in issue.

Mergers and takeovers

If a merger or takeover results in one constituent in the FTSE 100 index (or FTSE 250 for that matter) to be absorbed by another constituent, there is a vacancy in the appropriate index. The highest ranking security in the appropriate Reserve List as at the close of the index calculation two days prior to the deletion is chosen.

If a constituent company in the FTSE 100 or FTSE 250 is taken over by a non-constituent company, the original constituent will be removed and replaced by the highest ranking non-constituent on the appropriate Reserve List.

The company resulting from the takeover is however eligible to become the replacement company if it is ranked higher than any other company on the Reserve List.

Company splits or demergers

If a member of the index is split or demerged into two or more companies, the resulting companies are eligible for inclusion as index constituents in their own right. This is again based on each new company’s market capitalisation (before the application of any investibility weightings).

It may be that the lowest ranking FTSE 100 constituent gets relegated to the FTSE 250, so when GUS demerged into Home Retail and Experian last October, Party Gaming was unfortunately relegated.

The FTSE 100 index is used as the benchmark for measuring the strength of the UK stockmarket, and some commentators have argued it has a natural bias to outperform the wider FT All Share index, because it tends to promote to its ranks those stocks which are in the ascendancy and remove others that are falling away.

About the Author:
Mike Estrey is the Head of Research for Blue Index, specialists in Online CFD Trading, Contracts for Difference and Online Forex Trading.

Article Source: http://www.eArticlesOnline.com