The top five firms in the FTSE 100, which represent just over 38% of the index, are overvalued, acco...
The top five firms in the FTSE 100, which represent just over 38% of the index, are overvalued, according to some managers, creating significant market risk. Jeff Saunders, manager of Martin Currie's UK Growth fund, says, not only do these companies represent far too large a proportion of the index, they are also expensive when assessed using traditional valuation methods, such as price to earnings.
Valuations, says Saunders, rocketed in the flight to quality that followed the bursting of the tech bubble in 2000, when institutions and investors rushed to invest in liquid stocks with solid earnings.
'AstraZeneca, for example, is at 30 times earnings on a year-to-date basis. Vodafone is at 35 times. This is a firm that because it has taken on so much debt, is technically not making any money at all and will not do so for several years,' he says.
This massive concentration generates skewed market risk, particularly affecting tracker funds. Saunders adds: 'The implication that a portfolio based on the FTSE 100 is safe and low risk is completely wrong. Any portfolio where you have placed nearly 40% of your assets in just five stocks is inherently unsafe. I would go as far to say the 27 stock portfolio I run is a less risky option.'
The concentration in the UK's leading stock market index is shown by the value concentrated in the top five firms within the FTSE 100.
As of 12 March 2001, the largest five firms in the index were BP (10.9%), GlaxoSmithKline (8.5%), Vodafone (7.5%), HSBC Holdings (6.2%) and AstraZeneca (4.8%).
This has been caused by the big firms getting even bigger by a series of mega mergers, such as Vodafone's takeover of Mannesmann and BP's link-up with Amoco. The attractiveness of such deals is because of a low inflation global economy, which means many of the UK's largest firm's have little or no pricing power, Saunders notes.
In a tough trading environment, says Richard Prew, manager of the Henderson UK Capital Growth fund, it makes sense for companies to look for ways to cut costs. He says: 'This is not good news for the UK equity market, as the level of concentration is in the wrong areas, ones that are not sensitive to an economic pick-up in the US. The effect is exacerbated by the UK already being a defensive market in global terms, compared with, say, those in the Far East.'
Prew says there is little correlational co-efficiency between the sectors that make up the 10 largest firms in the index, oils, telecoms, pharmaceuticals and financials. He says the underlying characteristics of these sectors are different, as are the factors that would drive growth in their stock market valuations.
He adds: 'At any given time, these stocks are unlikely to be moving in the same direction. As they are usually considered to be the main drivers of the economy, it is highly unlikely that investors in blue-chip tracker funds will see substantial growth in their investments in the near future.'
Prew has been adding value to his portfolio by underweighting these stocks but, as he is benchmarked against the FTSE All-Share, he is obliged to place a major proportion of his assets in them. At the same time, he has been trying to seek out growth stories in the remaining areas of the index, which is outside the top 10 and the mid-cap sector.
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