This is particularly relevant in the case of the FTSE All Share Index at the moment as 29 new companies are set to join the index on 23 June.
“I am not sure how many investors realise that owning an index fund means having to buy every new issue or new entrant to the FTSE All Share Index,” said Simon Gergel, CIO for UK equities at Allianz.
“The changing of index constituents can have some important consequences; index tracking funds buy the stocks in the index simply because they are there,” Gergel continued. “So, when an index changes they have to buy the new entrants and sell or reduce holdings in those stocks which are ejected or whose weightings are reduced,” he added.
Gergel said that many of the current crop of new index entrants into the FTSE All Share like Appliances Online and Poundland, are IPOs being sold by private equity owners. The vendors can choose their timing to coincide with favourable market circumstances, which normally means relatively high valuations, he explained.
Companies seeking to list shares can often take advantage of the situation with index funds. “The behaviour of index funds is well understood by the IPO vendors and their advisors and is often a point of discussion during investor briefings,” Gergel said. “It is very helpful when selling a business, or even when buying one, to know that there is another big potential buyer of your company, irrespective of price,” he added.