Why the FTSE 100 obsession?
It’s been another busy day for global equity markets, with the media’s FTSE 100 obsession seeming to continue unabated.
The index of leading UK company shares closed down 2.64% on Tuesday, falling by 193.58 points to close at 7,141.40 points. It was the biggest one day fall for the index since the EU referendum vote in June 2016.
It means the index has now surrendered all of its gains for the year, but critically it remains above the psychologically important 7,000 level.
The more sensationalist headlines will no doubt refer to £50bn being ‘wiped off’ the markets today – they never seem to report when that much is ‘wiped on’.
But why, when we talk about UK equity markets, do we constantly focus on the FTSE 100?
The Financial Times Stock Exchange 100 Index, as it is more formally called, is a share index of the 100 companies with the largest market capitalisation listed on the London Stock Exchange
The index is maintained by the FTSE Group, a subsidiary of the London Stock Exchange Group.
The index started life on 3rd January 1984 at a base level of 1,000 points.
The highest closing value to date was 7,778.64 points, reached less than a month ago on 12th January 2018.
One reason that commentators often refer to the FTSE 100 as a bellwether for UK equity investments is the size of companies represented by these 100 largest businesses.
These companies represent about 81% of the entire market capitalisation of the London Stock Exchange.
It’s for this reason that the media tend to focus on the FTSE 100 when reporting market movements. It’s size and also the relative simplicity of a market capitalisation weighted index of the 100 biggest UK listed companies makes the FTSE 100 the go-to index for reporting investment related news.
However, many of the companies in the FTSE 100 have an international rather than UK focus; an estimated 70% of the revenues for these companies come from overseas.
There’s also a huge amount of commodities exposure in the FTSE 100. Oil and gas companies are represented by around 13% of the index, with mining and extraction businesses making up around 23%.
What this means for investors is global events have a disproportionate influence on index movements.
A more comprehensive and representative index for UK investors is arguably the FTSE All-Share.
Originally known as the FTSE Actuaries All Share Index, the FTSE All-Share includes around 600 of the more than 2,000 companies listed on the London Stock Exchange.
It aims to represent at least 98% of the full capital value of all UK companies that qualify as eligible for inclusion, making the FTSE All-Share a more comprehensive measure of UK company success than the FTSE 100.
In fact, here at Informed Choice our preferred index tracker fund for UK equity market exposure aims to track the performance of the FTSE All-Share, not the FTSE 100.
Turning to performance, the FTSE 100 and FTSE All-Share post different returns, although tend not to deviate too wildly.
Today for example, the FTSE All-Share closed down 2.54% compared to the 2.64% loss reported for the FTSE 100.
It’s not just here in the UK we have a problem with a media focus on a slightly inappropriate market index.
Over the pond in the US, American commentators like to use the Dow Jones Industrial Average as their favourite reference index.
This is an index of only 30 US listed companies, first calculated on 26th May 1896. Unlike the FTSE 100 or FTSE All-Share, the Dow Jones uses a price weighted methodology, meaning that companies with a higher share price have a bigger impact on movements in the index.
A more diverse US stock index, with a different weighting methodology, is the Standard & Poor’s 500, usually known as the S&P 500.
The S&P 500 didn’t start until 1957 and consists of the 500 largest publicly traded American stocks.
Companies included in the S&P 500 are weighted by their market value rather than their stock prices. This is a similar approach to the FTSE 100 and FTSE All-Share market capitalisation weighted approach, attempting to ensure that a 10% change in a $20 stock will affect the index the same way that a 10% change in a $50 stock will.
The lesson from this blog is, I hope, relatively simple; when listening to media reports about the FTSE 100 or Dow Jones, think about what those indices represent and how they relate to your own experience as an investor.
In the case of clients of Informed Choice, who have well-diversified portfolios invested across a range of different investment types, the movement in the value of the FTSE 100 on any given day has little relevance at all to their own portfolio value.
In any case, short-term market movements have little relevance when considering long-term financial goals.
When constructing financial plans for our clients, we factor in this type of expected short-term volatility to ensure it has no lasting impact on achieving future financial goals.
The next time you hear the newspapers or rolling news channels screaming about the FTSE 100, pay them a little less attention than you might have done before.