Trackers funds are more exposed to house price 'bubble'

Investors who hold FTSE 100 tracker funds will be taking a bigger bet on Britain’s housing market later this month when housebuilder Barratt Developments is promoted to the index

Investors who have money in funds that track the fortunes of Britain’s largest companies will later this month be forced to take a larger gamble on the housing market revival.

On March 24 the make-up of the FTSE 100 index will be changed, with housebuilder Barratt Developments (LSE: BDEV.L – news) and financial advisers St James’s Place added to the list.

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The two firms will take the place of sugar firm Tate & Lyle (LSE: TATE.L – news) and Amec (Other OTC: AMCBF – news) , the engineering group, which they have outgrown.

The changes are part of a regular review of the FTSE 100 to ensure that it includes Britain’s biggest firms. Typically, no more than one or two firms are promoted from the FTSE 250, which is the second tier of companies by market value.

Investors should expect turbulence, analysts said, because of the way FTSE 100 “tracker” funds react to such changes.

These funds, which replicate the index by holding each share in it, will buy shares in Barratt and St James’s Place and sell the demoted stocks.

This pattern typically gives a boost to shares as they enter the index. Then, in the following months, these gains are often wiped out as institutional investors take profits.

Ben Seager-Scott, an analyst at Bestinvest, a fund broker, said these periods were a test of investors’ nerve.

“We expect the new shares to receive a boost, as normal. But once they are listed the tactical traders in the market will cash in. These investors are not looking at the merits of either company, instead they are taking advantage of the trend that newly promoted companies tend to get sold in the first couple of months.”

“Tracker fund investors should ignore this short-term volatility, and instead focus on the long-term reasons they backed larger British companies.”

A study published in 2011 by Smith’s, a stockbroker, concluded that newly promoted companies found it difficult to stay in the FTSE 100 because investors initially sell the shares.

The report argued that investors tended to take profits because these firms had typically been the best performing shares in the market before the promotion. This leads investors to cash in and invest in shares they see as offering better value.

This scenario will sound familiar for investors in Barratt Developments. The company’s share price has risen by 84pc over the past year as the housing market has recovered. Adding a housebuilder to the FTSE 100 will give tracker fund investors more exposure to the property market, which some believe is now in “bubble” territory.

St James’s Place has risen by 63pc. By comparison, the average FTSE 250 share has gained 19pc.

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