How useful are indices? Passive investors may view them as an aid to low cost investment, replacing or alongside active management. But the last 12 months has shown some shortcomings. Indices themselves may not be a good representation of the economy, or of the best listed companies available.
The Hill Review of UK listings, published this month, said of the FTSE Index; “the most significant companies listed in London are either financial or more representative of the ‘old economy’ than the companies of the future”. And the report also highlighted another concerning trend; the number of listed companies in the UK has fallen materially from its 2008 peak, as companies are acquired or go private. Investors in UK equities should note both these stockmarket patterns.
Many companies are now choosing to delay IPO, as a well-financed private equity eco-system provides ready finance for rapid growth. Successful businesses are staying private for longer, with investor access primarily through private equity or listed funds specialising in private assets. Remarkably, the FTSE 100 itself includes management groups and funds specialising in private equity and alternatives, such as Scottish Mortgage, Intermediate Capital and Pershing Square. Passive funds replicating the FTSE 100 Index now include actively managed investments but with an additional layer of cost.
With disruption likely to continue in many sectors - irrespective of any pick-up in inflation or rotation to value - growth will remain scarce. The fastest growing businesses are more likely to remain outside the market or to be a small part of traditional indices. The Hill Review should create opportunity for a more dynamic London stockmarket, attracting listings of bigger global growth businesses. But for now, the value in the Review is in highlighting how much the world has changed since the main indices were designed. As the Report puts it; “at one point last summer, Apple alone was worth more than the combined value of every company in the FTSE 100”.