Smaller companies are neglected in a market that adores the top 100 firms
Saturday 30 August 1997
Anyway, far be it from me to suggest that one of the UK's most famous and successful corporate raiders has passed his sell-by date.
If it happens it will be a result of pressures from both without and within. First of all, Hanson has been busily divesting itself of the interests built up through two decades of aggressive acquisitive management.
The departure of Imperial Tobacco from the group has finally brought the market capitalisation to a point where Hanson only just justifies inclusion in the index. Then you have the new Young Turks of the stock market - those newly de-mutualised financial companies that are knocking on the door of the Footsie.
Both Woolwich and Norwich Union will enter the index when it is rebased in September. With market capitalisations of more than two and three times that of Hanson respectively, such a move is inevitable.
These changes emphasise the predominance of financial stocks within this index and serve to remind us that the Footsie is an index made up of successful companies.
Anticipation of entrants and departing companies is something of a City pastime. If, as a company, you look like gaining admission to the index, buyers emerge. Appear close to falling out and you will be friendless in the investment community. All rather sad really, particularly as Britain's smaller companies could do with a bit of support.
Support was not forthcoming in a recent report by one of the country's leading investment banks, suggesting Britain's second 250 companies were net losers in the changes resulting from the Budget measures on the tax treatment of dividends for pension funds.
According to HSBC Investment Bank, the shares of Britain's second-tier companies could fall out of favour with investors.
They reason that pension fund managers will be looking increasingly at dividend cover, the number of times dividends are covered by earnings, in an effort to invest in those companies best able to replace the loss of tax credit, by upping their annual payments.
It seems that, on balance, dividend cover for these particular companies is rather less than that enjoyed by Britain's top shares.
For those who missed this particular measure in Gordon Brown's first Budget, the ability of pension funds to reclaim the Advance Corporate Tax on UK dividends has been ended.
For UK investors, ACT, which is presently 20 per cent, is offsettable against the overall tax bill. A 40 per cent taxpayer thus has only a further 20 per cent to pay on any dividend received from a company.
Until the Budget, pension funds could reclaim this 20 per cent tax and thus increase the gross yield on investments. The ending of this practice has effectively cut the income return that pension funds receive on their assets by one-sixth.
The Chancellor was minded to introduce this measure in part to raise money for the Exchequer, but also to encourage companies to pay less out by way of dividend and reinvest more in their business.
HSBC surmises that this is unlikely to carry much weight with actuaries, who will be looking at the guaranteed return dividends can provide. These investors may be seeking to replace dividend income, perhaps by buying gilt edge stocks or investing in companies capable of upping their dividend regularly. Then there is the fact that these companies may need to replace the loss of revenue by raising the contribution to their pension funds.
This HSBC study showed that a number of companies had pension schemes likely to need a higher level of contribution, with all that means for profitability.
This added overhead comes at a time when many companies must be wondering if the consumer boom of recent months can continue for much longer.
I will not bore you with the arguments over the size of a pension fund in relation to the market capitalisation of the company involved, or the assumptions made in terms of growth of pension fund assets required to meet expected liabilities.
Suffice it to say that yet another cloud has passed across the horizon of those looking for a new dawn for smaller companies.
Global investors who chase the big companies are having it all their way, making indexed funds look evermore attractive. These funds have yet to be tested in a real bear market. Just remember markets do not go up forever.
Brian Tora is chairman of the Greig Middleton Investment Strategy Committee and may be contacted on 0171-655 4000.
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