Investing in equities is very risky: the price of shares in a company can slump dramatically in a matter of hours and the business can even go bust, wiping out your investment altogether. But some types of equity investments are generally considered riskier than others.
Most UK investors buy shares in companies listed on the London Stock Exchange (LSE) for a series of reasons. Many companies listed on the LSE are British businesses that investors know well. These shares are also priced in pounds, so you don’t need to worry about the prospect of currency movements directly affecting the value of your holding. Still, bear in mind that if a firm makes some sales abroad, changes in foreign exchange rates can still affect profit levels and hence share prices.
However, there is an important distinction to be made between companies listed on the LSE’s main market and its junior exchange, the Alternative Investment Market (AIM).
The main market of the London Stock Exchange, established in 1698, currently includes more than 1,000 firms, from corporate giants such as Vodafone and BP to smaller companies like Topps Tiles and Punch Taverns. The 100 largest companies in the main market make up the blue chip FTSE 100 Index, while the FTSE 250 Index is comprised of mid-sized firms.
Companies on the main market are required to meet strict listing rules tougher than those applied to companies listing on AIM, giving investors more confidence and greater protection.
Generally speaking, companies on the main market tend to be larger, more mature businesses, but the LSE still imposes strict regulations on the companies listed.
To qualify for a premium listing, which includes access to the FTSE indices, companies must meet basic qualifying criteria. The company has to be worth at least £700,000, for example, and it must make at least 25% of its shares available to the public. It must have three years of independently-audited accounts and it must have had control over the majority of its assets for at least three years.
These are important safeguards that mean investors in the business can be confident it is an established company that hasn’t just appeared out of nowhere. Moreover, additional rules ensure that investors are able to keep a close eye on the businesses they have backed (or are considering for investment).
Main market-listed companies must publish an audited annual report within four months of the end of their financial year, as well as more basic half-year reports within two months of the end of this period. The London Stock Exchange also requires firms to publish an interim management statement twice a year, between the annual and semi-annual reports, to update investors on the business.
Companies are also bound by the UK Corporate Governance Code, which sets standards for how companies are run and their relationship with shareholders – those businesses that don’t meet any of the standards must say so and explain why they have chosen not to comply.
Another advantage of the LSE’s main market is that it operates with an electronic order book. This means every investor buying and selling shares in a particular company places their order through the Stock Exchange Electronic Trading Service (SETS) – in practice, your stockbroker or online trading platform may do this on your behalf – detailing what price they are prepared to buy or sell at, and how many shares they want to buy or sell.
Everyone else considering investing in the same company can look at all the orders placed at a given time. This means the system is both transparent – you can see what prices people are willing to trade at – and liquid, in that investors always have access to the maximum possible amount of demand and supply.
By contrast, other markets operate using a quote-driven book (as did the London Stock Exchange until the 1990s). This relies on dealers, or market makers, who post the prices they are prepared to accept for sales and purchases of shares in a particular company at any one time. This is a much less transparent system, since there is no way of knowing what trades other investors dealing with the market maker are hoping to make.
Also, liquidity depends on the market makers – if only one or two dealers choose to trade a particular stock, sale volumes may be quite low. Lower liquidity means there is less likelihood of investors being able to buy or sell at the price they choose.
Investing on the main market, in other words, gives investors access to larger, more closely regulated companies, via a dealing system that produces greater transparency and liquidity.
Remember that all investments can fall as well as rise in value and you may get back less than you invested. Investing in individual shares is not suitable for everyone, and they should usually only be held as part of a diversified portfolio. If you’re unsure, seek independent advice.
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