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Comment: Nothing endures but change

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Over time holding a stock market index can lead to unwanted problems. In the latest edition of Global Perspective, Standard Life Investments examines how a variety of factors, such as M&A activity, mean that the composition of an index can alter dramatically over, say, a decade. Andrew Milligan, Head of Global Strategy, says…

Investors can draw several conclusions from our analysis of how stock markets change over time. Firstly, they should be wary of valuation bubbles appearing; sharp changes in the composition of a market can often be a trigger to monitor portfolios – especially if these are associated with changes in investor sentiment and behaviour. Energy in the 1970s, TMT in the 1990s and financials in the 2000s all exhibited warning signs, as investors priced in long-term earnings growth which ultimately did not prove correct. At present, the rise of the commodity sector should be examined carefully although earnings growth currently supports a large weighting in many indices.

Secondly, such analysis is a strong argument for active management – for example, buying into faster growing mid-cap names that offer value, strong earnings prospects and the potential for promotion into the major indices, rather than necessarily concentrating on the most popular, over-researched larger cap companies. Finally, the combination of surplus cash flows and low costs of debt are leading to buybacks and hence fewer shares being available.

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