The prospect of Scottish independence raises a number of issues, one of which would be the merits of a passive fund to track Scottish companies. There are many uncertainties to be resolved affecting Scottish companies such as currency, banking supervision and regulatory regime. Nonetheless, working on the premise that existing listed Scottish companies (as defined by the Scotsman’s Scottish Share Index) retain their domicile in Scotland post-independence, what would the index look like? And does it represent an attractive investment proposition and a means of gaining exposure to traditional strengths such as whisky, financial services and the energy sector?

From the outset the index, calculated using market capitalisation and valued at £64bn, would suffer from overexposure to a limited number of companies because the universe of 33 stocks is quite small. Royal Bank of Scotland (RBS) would presently represent 40% of the index weighted by market value. This is despite the fact the share price has fallen 95% or so from its peak. Adding Standard Life (9% of the index), Aberdeen Asset Management (5%) and Alliance Trust (3%) and F&C (1%) would further increase the dominance of the financial sector to almost half the index. The next biggest would be SSE, the gas and electricity utility, at 18%, followed by the engineering companies Aggreko and Weir, at 7% and 5% respectively. Replicating such an index through an OEIC would be impossible given the constraints on the maximum holdings size to limit concentration.

Given the dominance of a handful of companies in the Scottish index, a passive fund tracking the index would have given a very volatile ride. FTIM carried out some simple back-testing on the index over a 10 year period, rebalancing the index by market value at the beginning of every year. From the start of 2002 to the start of 2012 the index would have fallen 30%, dragged down by the performance of HBoS and RBS which made up over two-thirds of the index for the first 6 years. This year it would have staged a bit of a recovery as RBS has risen sharply, jumping 24% by the beginning of November.

Using market capitalisation to track markets has a number of problems so a fundamental process may be better with a relatively small collection of stocks. Indeed, this seems to be case. Using dividends gave a better capital return of 7%…

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