How investors can (just) make money tracking FTSE 100 relegations and promotions

“However, our research that covers all of the quarterly index reshuffles since 2013 shows that buying all promoted firms would have been a profitable strategy. Equally, the data shows that relegated firms tend to do less well, on average.

Source: Thomson Reuters Datastream, FTSE Russell. Covers 43 relegations and promotions according to scheduled quarterly index changes and excludes any changes due to merger or acquisitions during a quarter. Returns exclude taxes and dealing costs.

“However, anyone looking to deploy this as a trading technique needs to be aware that there are some spectacular exceptions to the rule, which suggest that momentum players looking to follow promoted stocks need to take care that they do not buy in when a firm’s fortunes are at their zenith. After all, elephants don’t gallop and in some cases companies have reached the FTSE 100 only to run out of puff very quickly and prove a disappointment to buyers.

Source: Thomson Reuters Datastream, FTSE Russell. Covers 43 relegations and promotions according to scheduled quarterly index changes and excludes any changes due to merger or acquisitions during a quarter. Returns exclude taxes and dealing costs.

“In addition, it has been possible to take a contrarian view and snap up shares in firms which turned out to be a bargain, as the threat of demotion led to the stock becoming oversold. It could be the relegation followed a short-term blip in trading rather than a fundamental downturn, or even a negative shift in sentiment toward a wider sector which dragged down all of the companies within it, whether they had done anything wrong or not.

“A good example here is Babcock International which was kicked out of the index in December as the support services fell out of favour, following a long string of warnings from sector peers such as Mitie, Serco, Capita and particularly Carillion, even though Babcock itself did not issue a trading alert. The shares have risen by a fifth since their demotion as value-hunters decided the stock had become oversold following a vicious de-rating in the shares, which saw their forward price/earnings ratio plunge from the high teens to the high single digits over a two year period.

“Contrarian investors continue to assess Babcock’s operating model and argue that it offers more value added than many of its sector peers, since its skills in servicing nuclear submarines and training troops are not readily available elsewhere, so this may be a barrier to entry which means the firm can continue to generate orders and consistent profit and dividend growth. Time will tell whether this view is correct or not but for the moment relegation from the FTSE 100 – and the torrent of selling by index-trackers, exchange-traded funds and possibly some active managers which accompanied it – seems on this occasion to have created a buying opportunity.”

Source: Thomson Reuters Datastream, FTSE Russell. Covers 43 relegations and promotions according to scheduled quarterly index changes and excludes any changes due to merger or acquisitions during a quarter. Returns exclude taxes and dealing costs.