FTSE 100 Index Diversification and Performance

This assignment explores the effects of diversification on the FTSE 100 index performance. It examines the correlation between FTSE 100 and other indices like REITs and UK Investment Grade Bonds. The analysis delves into whether increasing assets within the FTSE 100 leads to greater profitability, considering modern portfolio theory and the potential impact on investor returns.

CORPORATE FINANCE

INTRODUCTION
In the financial sector there are corporate finance having an integral place which helps to
a business organisation in order to take investing decisions in the highly appropriate manner. By
considering the corporate finance aspect management of an entity able to deal with the financing
sources and make the capital structure in the proper way. If it not considers the capital structure
and corporate finance then not able to raise fund by making profitable proportion like as debt as
well as equity financing. The current study is about the FTSE 100 which is an index of the
London Stock Exchange market and diversified in several kinds of segments. On the basis of the
present report the reader able to understand and analyse that when the current index add the new
and additional assets in its existing portfolio then it will not generate the benefits in term of
diversification. The reason and causes behind not affecting new assets to the FTSE 100 is to be
provided along with the empirical evidence in through the respective report. The current report
of the corporate finance shows and focuses on the modern portfolio theory which relies with the
main two aspects of the investment and portfolio which are like as risk and return. There are
three kinds of empirical evidences are to be discussed of the FTSE 100 statement at here which
are like as opportunity cost, index fund and volatility of the stock market.
MAIN BODY OF ESSAY
At the every kind of business entities there are corporate finance having a key part in
order to assess the appropriate funding sources and make the investment as well. With the help
of this respective method the management able to make the portfolio for putting money in
various aspects and avenues of the investment which are available in the market. In the portfolio
different investment avenues are considered which are like as equity shares, preference shares,
debentures, real estate, commodity, precious items, gold, silver etc. In the corporate finance
mainly four kinds of steps are followed and adopted by the company for making investment it
(Vernimmen and et.al., 2014). Further, the stages and phases are like as planning, raising the
finance, investing as well as monitoring that whether it providing return in the positive ways or
not. In the stock market there are different indexes available where the investors put money and
generate return or loss as per the market condition. In the current case study there is FTSE 100
indices is to be analysed which is one of the highly traded in the London Stock Exchange market.
The current kind of the index is diversified in several types of the companies which are operating
in the different number of sector such as oil and gas, energy, retail, telecommunication, banking,
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service, consultancy, food processing, manufacturing, infrastructure etc. At this point it has been
said that if the FTSE 100 add one more kind of asset and company in the existing portfolio then
it will not gain any kind of benefits and advantages because of already diversified in he several
sectors.
In the market index of the FTSE 100 there are huge number of the companies are listed
which issue their shares in the market with the help of stock exchange market. There are several
kinds of shares like as equity, preferred, preference, debentures etc. issued by the companies
using two processes such as initial public offering and follow on public offering which are
different up to some extent (Kumar and Mishra, 2016). Among these both the processes there is a
similarity that these help to the business entity in order to issue equity shares in the market. The
company when gone through the listing process in stock market then issue equity shares at the
first time that will consider as initial public offer. On the other side when a company issue its
shares and stock in the market for raising fund at the second or more time, then the process is
known as follow up public offer. Motive of adopting both the processes at the workplace is to
raise fund and enhance capital in the company for business expansion, purchase new plant and
machinery or any other business purposes. This is one of the key and important part of the
corporate finance and implied using the different indices of the stock market like as FTSE 100.
By using the diversification strategy the investor able to reduce overall risks of the investment
which they made in different kinds of avenues. Along with this level of the profit and amount in
terms of the return also generates up to the higher level. When comparing and analysing both the
aspects of the investment such as risk and return then it can be said that higher the risk taken by
the investor able to generate more return (Jorda, Schularick and Taylor, 2016).
What is Diversification:
In Finance diversification is the process of allocation capital in a way that reduce the
exposure to any any one particular assets or risk. A common path or way towards diversification
is to reduce risk or volatile by investing in varieties of assets. If assets price do note change in
perfect synchrony a diversified portfolio will have less variance then weighted average. Variance
of its constituent assets, and often less volatile then least volatile.
It is risk management technique that mixes a wide variety of investment within a portfolio.
rational behind the technique contends that portfolio constructed of different kinds of investment,
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will on average high yield return, and pose a low risk then any individual investment found
within the portfolio (D'Aurizio, Oliviero and Romano, 2015).
Diversification strives to smooth out unsystematic risk events in portfolio so the positive
performance of some investment neutralise the negative performance of other. Therefore the
benefits of diversification holds only if the securities in the portfolio are not perfectly correlated.
Studies have shown that by mathematical mode as well as diversified portfolio of 25-30 stocks
yield the most cost effective level of risk reduction. Investing in more yields further
diversification benefits abide all drastic same rate. Further diversification benefits can be gained
by investing in foreign securities because they tend to be loss closely corrected with domestic
investment. For ex, an economic down in us economy may not might affect Japan's economy in
the same way, therefore having Japan's investment gives an investor a small cushion of
protection against losses due to American economic downturn. If the prior expectation of the
return on all the assets in the portfolio and identical, expected return on all the assets and
portfolio are identical, expected return on diversified portfolio will be identical to that on an
undiversified portfolio.
Need of diversification:
Diversification is technique that reduce risk by allocating investment among various
financial instruments, industries and other categories. It aims to maximise return by investing its
different areas that would each react differently to the same events. Most investment professional
agrees that although it does not guarantees against loss. Diversification is long term tool to
achieve goal by minimising risk. So need or importance of diversification are
11 Help reduce risk: No one can predict how assets or class of assets will behave or give
return in future. So by spreading your investment across different class of investment like
equities, bonds, cash and real estate can reduce the portfolio risk. A portfolio can be
diversified with each categories of investment. For ex even in equity, investing in
different stocks across varied sectors or market capital would mean different categories.
This will ensure that lose in one sector will cover by high return in another stocks.11 Help to avoid the loss arises during bad timing or bad decisions: The advantage of well
diversified portfolio can certainly be seen over long period. (Davidson, Dey and Smith,
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2015) Many investors get carried away by market movement and take emotional
decisions rather then financial planned decisions.11 Diversify based on assets allocation that is right for investors: Assets allocation is an
essential tools in diversifying investment portfolio. I refers to getting the right mix of
investment options aligned to risk profile, life stage time zone. making regular check
rebalancing insurance that risk is maintained and portfolio meets investment goals.
Advantages and Disadvantages of Diversification:
Diversifying investment portfolio can protect from localised dip in market but it can also
help in making big money in market. So Advantages of diversification is
1. Risk Reduction: When your assets are widely diversified, portfolio tends to perform in
simple way to market as a whole. Of anyone owns a stock in 20 different areas and one of
them takes dive its likely that portfolio will suffer. So Diversification is the best way to
increase the stability of investment and decrease in value. Although diversification won't
protect from general slowdown. It will maintain your portfolio stability over time.
2. Assets choice: When investor hold wide variety of stocks, we can spread them over wide
diverged form of assets, Including activities such as stock and bonds, Commodities such
as oil and minerals, real estate or cash. Each of these stock holds different strength and
weakness in term of risk and profitability (Thune, 2016). Maintaining and holding all
these areas helps to create stable portfolio that will increase the value in long run.
3. Low maintenance: Investment require certain amount of care and attention to keep that
performing well. If investor is playing high stack games with your assets and moving
them around through risky venture, you will be planing a fair amount of time in watching
tha market and keeping eye on financial budget. A diversified portfolio is less exciting
and more stable. Once we have investment settled into wide variety of stocks and
securities they can remain their for long period without too much maintenance.
Disadvantages:
1. Increased exposure: When holding are widely diversified, an investor will suffer some
amount of loss whenever some part of portfolio dips. If whole market is declining. It is
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more likely that the holding will also decline. So when an investor diversify his
investment an investor need to protect himself from excessive financial exposure.
2. reduce Quality: There are so many quality companies and even less are priced at levels
that provide margin of safety. The more stock put in portfolio the less concentrated your
portfolio will be in the best opportunity.
3. Too complicated: Many investors include so many assets in their portfolio that they don't
really understand what's in them. Diversification in investing is important but keeping it
simple to stay on top of investment is difficult.
Describe the FTSE
FTSE is financial time stock exchange 100 index also called FTSE 100 index. It was
founded in 1984 and operates in London stock exchange. In it 100 companies are listed in
London Stock exchange with highest market capitalisation. It is sign of prosperity for business
regulatory by UK company law. It is maintained by FTSE group a subsidiary of London Stock
Exchange company. It was originated as Financial times and London stock exchange Joint
venture. In it 100 companies are qualifying with full form market values and mostly companies
are international focused. So the index movement are fairly weak indicator of how UK economy
is fairing as seen in recent trends against starlings. FTSE 100 represents the 81% of the entire
market capitalisation of London Stock Exchange. even though the FTSE all share index is more
comprehensive FTSE 100 is by far the most widely used UK stock market indicators.
component companies must meet a number of requirement set out by FTSE group,
including have a full list of LSE with sterling or Euro denominated price on stock exchange
Electronic trading service, meeting certain test on nationality and free float and liquidity.
Weighting: In the FTSE index, share price are weighted by market capitalisation, so that
larger companies make more of the difference to the index than smaller companies (Ehrhardt and
Brigham, 2016) . Basic formulae of these indices are
Index level= ∑i Price of stock * Number of Share * free float adjustment factor / index divisor
FTSE isn't diverse:
In FTSE top 100 companies are listed adn each companies belong to different sectors like
Aerospace and Defence, Alternative energies, Auto mobile parts, banks, beverages, chemical,
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construction, insurance,health life insurance and many more so. In FTSE all these sectors have
many companies and further these sectors are not classed and all small and medium and large
stocks are listed in particular sectors. So These sectors need to be classified for making proper
portfolio. Investors are often told that key to success is long term portfolio is diversified and all
stock dont have in one portfolio. It is fair to say that most investors uses UK Funds, be it growth
or income fund, as their core exposure to the equity market then to try and make sure to fate of
savings isent the mercy of FTSE. All Share performance, they use global fund for purpose of
diversification. This market sense, given that large majority of fund, IA global and Global equity
income sector have low weighted to the market (Fazzari and Papadimitriou, 2015). These market
sense, given that large majority of funds, IA and global equity income sector have low weighted
to the UK market. Data from FE analyst shows that just because investors use global or even
regional fund to sit alongside their UK exposure, it doesn't mean that holdings won't move up
and down at same time. Diversification through gold, minerals, silver, property (BTL and Funds)
and cash can be done through diversity.
MODERN PORTFOLIO THEORY
In the stock market there are number of indices available and in which different number
of the companies are listed for raising fund and other objectives. In the current study there is
FTSE 100 which has full name is such as Financial Times Stock Exchange 100 is to be
addressed under which various segment's firms are listed and taking financial services such as
raising fund, issuing shares etc. At the investment market there are huge number of avenues are
available which are used by the investors in order to put and invest money. When the investor
going to make investment then analyse all the available criterias that which will give the better
and profitable return. After making analysis of such all the avenues the investor make portfolio
where it considers various criterias and the make investment which lead to manage both the
aspects associated with the investment. With each and every kind of investment whether it is
equity shares, real estate, debentures or any other than there are risk and return both are always
associated which are considered by the individuals who are going to make investment (Li, 2015).
In this context there are Modern Portfolio Theory is to be consider and imply where diversified
portfolio is to be prepared and then decision for investment making is to be taken in the
appropriate manner. The portfolio under which different aspects of the investment are considered
and then money is to be invested is called as diversified portfolio which is necessity for each and
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every investor. The reason is that it provides the highly proper instructions and helpful for
minimize level of risks and maximize level of return. In the modern portfolio theory balance is to
made among the level of return on investment and risks.
By using the modern portfolio theory the investor able to reduce the overall risk and
manage the return up to better extent. In the portfolio there are all kinds of avenues not provide
same return, some provides the higher and positive return but some cannot (Modern Portfolio
Theory (MPT), 2013). When the investor put money in the equity and preference shares the
return can be positive or negative both because of depending on the fluctuation of stock market
and FTSE 100's value. Further, there are T-bills and real estate not having the negative return,
they always provide positive and higher return as the time passes. Further, when relating to the
return with the time factor then there is positive and direct relationship. When the investor make
investment for the longer period then get the amount of return at the higher level which is
profitable for the individuals. In the modern portfolio theory there is mainly two assumptions are
made while making the portfolio for investing money which are like as risk and return (Cole and
Sokolyk, 2016). In the equity as well as preference shares the return is in form of dividend
amount which is on the basis of index value as well as profit of the company. Moreover, the
current presented theory is highly helpful for the investors for reducing the risks and improving
return on consistent basis. By making portfolio if one or two avenue give negative or lower
return and other provide positive and higher return then overall amount of the return comes
under the balance. Along with this the investor not needs to take the risk because it leads to
reduce the overall risk associated with the portfolio.
In this context when the FTSE 100 consider the modern portfolio theory then able to
manage the overall assets and sectors which are listed in the stock market's current index (Macve
, 2015). By this the management of the stock market able to know that in which proportion the
sector will be divided. The respective kind of theory of portfolio highly better for the investors
which lead to provide them more return and make them more financially sound. With the
investors when there are level of risks are higher, then it will provide more return of the
portfolio. There are different kinds of the risks associated with the portfolio which are such as
market, systematic, unsystematic, stock etc. To reduce and avoid the risks of investment and
portfolio there are the current analysed theory is highly better for the investors.
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By considering these all when the FTSE 100 add one more asset and company within the
market and index then not generate any kind of benefit ad well as profit because proportion for
every sector are already been fixed (McCahery, Sautner and Starks, 2016). When each and every
shareholder and investor going to make the highly appropriate and profitable investment the they
mus need to consider the modern portfolio theory. Because of this current theory as well as
approach the individuals who make investment able to generate as well as earn the higher return
along with the reducing risks of portfolio. Apart from this there are huge number of business
entities of every segment are listed by which it can be said that the FTSE 100 indices is
diversified in the existing condition (Cassar, Ittner and Cavalluzzo, 2015). Hence, it can be
clearly said that due to adding one more firm and asset FTSE 100 will not be profitable and
beneficial in any context. Evidences of the current statements are explained as below:
VOLATILITY
In the market if there are more number of companies listed in then the level of prices
fluctuate up to the higher level which is not good and profitable for the FTSE as well as investors
both. Higher the companies lead to create burden on the management of stock market in terms of
issuing shares, completing listing process, providing dividend amount to the shareholders etc. If
there are number of assets are at the huge number then the stock market will not able to manage
the smooth functioning of the market. In addition to this, there are companies also not able to
assess the appropriate prices of the shares and stock which is issued in the market place. Because
of fluctuating and volatile in the huge numbers then company cannot predict that in the future
times prices of its shares will be increases and reduces (Johnstone, 2015). On the basis of this
management of the public and private listing business entity determine that level of investors in
order to invest money will be improve or not. When there are stock prices will enhance along
with the profit level of the firm then higher number of the shareholders start to purchase its stock
and shares. Due to this condition the business able to raise amount of the capital and fund up to
the better and higher level. Furthermore, due to the higher volatility the management of the
FTSE 100 will not capable to manage which is the negative impact on it rather than become
advantageous in terms of diversification.
Lagoarde-Segot, (2015) critically evaluated that when the Financial Times Stock
Exchange 100 include as well as add the new and additional assets in it then prices of the overall
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business entity's shares fluctuate up to the higher level which is negative impact for it. Because
of enhancing the price volatility of the shares the management of FTSE 100 will not capable to
manage and run the overall index in the proper ways. Due to the reasons of more volatility the
stock market will not generate any kind of benefit but because of adding new asset it will come
under the negative condition. Volatility of the stock market lead to reduce taking appropriate
investment decisions up to the higher level as well amount of the return also fluctuate up to the
greater extent. Higher the proportion of volatility lead to increase risk of the portfolio and
investment as well as less number of the stockholders attract for put money in stock market index
such as FTSE 100 (Abroud and et.al., 2015). The volatility of the stock and shares is based on
the different kinds of prices which are fluctuated in every three seconds. Because of this to add
more number of assets in the current index of stock market there are rather than generating profit
it affects in the negative way. Due to which it has been assessed and analysed that while adding
more assets the Financial Times Stock Exchange 100 is not beneficial in terms of the
diversification. Volatility is considered at that situation where the market condition and values
goes up and down within very fewer time such as two, three or four minutes. Because of this to
manage the smooth functioning of the whole stock market gets hamper up to the higher extent
and lead to reduce capability of taking appropriate investment decisions by the investors
(Musacchio, Lazzarini and Aguilera, 2015).
Apart from this all it can be said from the point of views of shareholders as well as
investors that because of adding more assets the price volatility in the market improves and
enhances. Because of this current situation there are investors and shareholders cannot make the
decisions for investing money in the share market because of fluctuating the prices. When the
prices are volatile in the higher number then the individual cannot assess that in the future there
will be what kind of condition arises. It may be happen that sue to higher stock market volatility
the investor will generate lower return along with the high risk (Andriosopoulos and Lasfer,
2015). On the other side, there are anyone cannot predict that in the upcoming scenario level of
the return will go higher or lower because of based on the stock market fluctuations. In addition
to this, because of the price and stock market volatility there are return of the investment also
affects in the negative way up to the higher extent along with enhancing the risks. Hence, it can
be critically said that Financial Times Stock Exchange 100 (FTSE 100) is not profitable as well
as beneficial after adding and enhancing assets in the index. In context to this, there is the current
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index of London Stock Exchange market is already diversified as well as companies of many
more sectors are to be listed in it. Moreover, there is no benefit and advantages for the FTSE 100
index after taking and listing more number of the firms in its stock market (Bacchetta and
Benhima, 2015).
Three Empirical Evidence
Data of Market Index for five years:
Name of Index
Year Emerging market index
Vanguard UK Investment Grade
Bond Index Reits
FTSE
index
2012 1019.39 49.31 149.38 5575.5
2013 1069.01 52.11 167.41 6654.3
2014 936.53 52.32 158.29 6855.8
2015 961.61 58.15 215.76 6984.4
2016 742.37 54.61 204.71 6270.8
Calculation of correlation of above mentioned market index with the FTSE index
Correlation among Emerging Market Index and FTSE index:
Particulars Emerging market index FTSE index
Emerging market index 1 0.0069
FTSE index 0.0069 1
At this current correlation among FTSE index as well as Emerging Market index value of
the correlation is such as 0.0069 which shows that among these both the indices there are very
low relations. It clearly indicates that if there are FTSE index will change and increase then value
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of another index will be increase with only 0.0069. Furthermore, the key reason to determine this
very low correlation is that in he FTSE there are is only UK relies but in another index there are
all the developing as well as emerging countries are included. Moreover, if FTSE will get change
or fluctuate then very low impact will be there on Emerging Market Index.
Correlation among Vanguard UK Investment Grade Bond Index and FTSE index:
Particulars FTSE index Vanguard UK investment Grade Bond Index
FTSE index 1 0.69
Vanguard UK investment
Grade Bond Index 0.69 1
Value of correlation among FTSE Index as well as Vanguard UK Investment Grade Bond
Index is such as 0.69 which is near to one and shows that there is very strong relationship
between both them. It can be clearly analysed that if value of the FTSE increase or decrease then
other mentioned index will also give response in same direction. Apart from this, both the
indices rely in the UK and due to which, if one index change then another will as well in the
same direction because of having strong relations.
Correlation among Reits and FTSE index:
Particulars Reits FTSE index
Reits 1 0.45
FTSE index 0.45 1
At last when compare and correlate FTSE index with the Reits then value of correlation
comes such as 0.45. In this it is moderate or middle value which clearly indicates that FTSE
index gets change then Reits index also gives response with the half value in same direction.
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CONCLUSION
By summing up the overall project of corporate finance it can be articulated that as
adding more number of business entities and assets in the index of London Stock Exchange
Market like as FTSE 100 there are any kinds of profit and benefit will not generate. Further,
because of increasing the diversified portfolio in which different kind of companies of carious
sectors are to be added the financial times stock exchange 100 is not become more beneficial as
well as not get profit. The cause and accountable aspect is that the index FTSE 100 is already
diversified and in this there are all sector's companies are listed. It can be concluded by
considering the modern portfolio theory that it helps to reduce and minimize risks which are
associated with the investment as well as overall portfolio. Along with this on the basis of the
current theory the investor is highly able to maximize and improve the return of the whole
portfolio under which investment is to be made. Moreover, on the basis of the index fund it can
be clearly analysed that the mutual funds are capable to prepare and generate the portfolio in the
profitable way but because of adding more asset it will not become beneficial. Because of the
adding high number of assets the investor loss their opportunity cost which lead to reduce level
of the shareholders towards the FTSE 100. It can be criticises that due to improving number of
assets price volatility enhancing which create burden on the management team of FTSE 100 as
well investors cannot generated positive and more return. Hence, it can be concluded by
considering all the empirical evidences that because of adding more assets in FTSE 100 it will
not beneficial in the diversified.
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