Loss of AstraZeneca to FTSE 100 will hammer home dangers of an over-concentrated index

15th May 2014

Investors have been warned that the loss of AstraZeneca to the FTSE 100 will only compound the problem of overconcentration in financial services and commodities on the UK’s main index writes Tony Levene.

Elal Miah, Investment Research Analyst at The Share Centre, says: “The loss of AstraZeneca from the FTSE 100 would hammer home the inherent dangers of index investing if the index in question is not well diversified across different sectors. The FTSE 100 is heavily biased towards commodities and financial services, with more than half of pre-tax profits in the last five years generated by commodities firms or banks.  Pharma has long been a crucial alternative, and has been the fourth largest profit generating sector since 2009. Given that AstraZeneca has made nearly half of the profits in the sector, its loss will mean investors in the index will have their cash even more heavily invested in oil, mining and banks. Commodity firms and the financial industry are much more likely than many other industries to be affected by global shocks, leaving UK investors relatively exposed, so it is important that portfolios are appropriately diversified to manage the potential risks.  Investors need to be very well aware what they are buying if they are considering an index fund.”

*       At industry level, Oil & Gas, Basic Materials and Financials account for 45% of the FTSE 100 weightings in terms of market cap.  By contrast, in the US S&P 500, they account for just 30%

*       Shell and HSBC alone account for 7%

*       Pharmaceuticals account for 7%

*       Analysis from The Share Centre’s Profit Watch UK shows that, at industry level, Oil & Gas, Basic Materials and Financials account for 65% of FTSE 100 revenues, 60% of pre-tax profits, and 53% of net profits in the last five years

*       Pharma has made up 8.6% of pre-tax profits in the FTSE 100 in the last five years, but only 2.8% of revenues – this is because pharma is extremely high margin, and why it delivers such big dividends to shareholders

*       AstraZeneca has been in the top ten companies with largest net profits in four of the last five years (they saw a drop in 2013 by 60.7%)

*       In the last five years, AZN has made up 3.9% of the FTSE 100’s total pre-tax profits, and 44.9% of pre-tax profits in the pharmaceutical sector

*       Pharma has been the fourth biggest contributing sector to FTSE 100 pre-tax profits over the last five years (8.6%), after Oil & Gas (24.3%) Mining (19.3%), and Banks (9.3%).  It is a valuable contributor to the diversity of a UK equity portfolio.  If/when AZN disappears, investors will only have GSK (and the much smaller Shire) in the pharma sector, affording them fewer opportunities to diversify their holdings.

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