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FE Adviser Fund Index

The resignation of Barclays chief executive Bob Diamond sent shockwaves through the City last week but for many investors it is a timely reminder that the consequences of the financial crisis are still playing out on the banking industry.

The news last week was undeniably shocking. One of the UK’s biggest and most respected financial institutions was linked to manipulating the Libor, which is used as a basis for setting broader market interest rates. The suggestion that a number of other institutions may also be swept up in the pandemonium has only added to the sense of unease.

Yet the economic significance of financial services is often overestimated in terms of its contribution to GDP, while its significance to the stockmarket is perhaps underappreciated.

A few striking figures make this clear. In 1997, the financial services sector accounted for 6.5 per cent of the country’s nominal GDP but during the next decade this figure grew to 8.5 per cent. Over the same period the contribution from manufacturing fell from 20 to 12.5 per cent.

The numbers should not be all that surprising. In a research paper entitled ‘Measuring financial sector output and its contribution to UK GDP’ by Stephen Burgess, the author underlines the sector’s recent growth:

He says: “In the decade before the financial crisis, measured output growth in the UK financial services sector averaged 6 per cent per year, compared with overall UK GDP growth of 3 per cent. The sector’s share of the economy also grew significantly and by more than in most other major advanced economies.”

These figures should tell us the financial services sector has grown in its importance to the UK economy but remains less than a 10th of total economic output. Meanwhile, the relative importance of manufacturing has fallen sharply but it still accounts for an eighth of nominal GDP.

However, they also help mask an underlying trend that is perhaps of greater value to investors. Between 1991 and 2011, the weighting to financials in the FTSE 100 index has risen from 13.9 to 20 per cent, having reached more than a quarter of the index in the early noughties.

This means that even after the impact of the crisis on their share prices, financials still play a major role in establishing the trajectory of the UK’s leading share index. With all of the uncertainty surrounding the sector, however, would any investor deem it prudent to allocate a fifth of their portfolio to the sector?

In effect, this is what those who invest solely in FTSE 100 trackers are doing. Many will use trackers as a hedge to cover short positions, or as low-cost equity exposure for short-term tactical allocations, but there is a risk of some retail investors finding themselves holding positions in businesses they would otherwise balk at.

As the Libor scandal threatens to spread, it is worth reminding those proclaiming UK equities still look cheap that the growth of one the most successful sectors of recent years seems to have stalled. Diamond’s inglorious departure should serve as a warning that the downside risks are not yet past.

Data supplied by FE

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