The FTSE 100 – time to reform this misleading indicator

18th April 2014

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The FTSE 100 – a fatuous financial fallacy

Seven Investment Management’s Justin Urquhart Stewart advocates reform of what he says is a misleading index

Every night we are fed the business news in fairly simplistic shorthand, and you can be sure that the final sentence will be what the FTSE 100 closed at today – higher or lower. This is given almost a cartoon indicator of the value, confidence and standing of the UK economy. In fact, of course, it is bares little or no relation to it. As we all know many of the constituents are not UK based and of those that are, they have a great proportion of their business dealings overseas. So an indicative temperature gauge of the UK economy – it most certainly is not.

So the FTSE100 has become the economic totem of the popular media, but worse than that it has become almost the default investment for many wanting to have easy and simple access to the stock market. It is my contention that this index has been a very misleading indicator for many and an unreliable friend to be investing in.

The FTSE100 changes quarterly and membership of the club is based on capital value. Thus much loved companies with rising share prices in fashionable sectors will take flight though the ranks and arise into the 100 Club. This, of course, is good for the share price as all the tracker funds have to hold those stocks, and even more important this is excellent news for the egos of the chairman and board as they now are also FTSE100 dircectors. Sad but true.

The problem is of course they keep changing, and if you are in a company which is heading in the wrong direction, then the pride of entrance can be swiftly followed by the pain and shame of being unceremoniously kicked out again.  Of course then you have to add further pain to their misery as those same FTSE trackers turn volte face and dump the shares and accordingly company values and pride are all affected.

However what this also means is that this index is not consistent. Unlike say the Dow 30 which changes very rarely or the S&P500 whose changes are barely registered amongst such a number, the nature and make of the FTSE has altered quite dramatically over the decades.

Sadly I go back to pre Big Bang, and the era of privatisations which boomed with their “priced to go” approach. Then we had the demutualisations, the Tech Media and Telecom boom of the late nineties, and then most recently the banking boom and inevitable bust. The result then is that if you look at the FTSE100 index it reflects a rollercoaster of rises and falls, such that as of today we have still not reached the peak that the FTSE 100 stood at in 1999. Investors, and often unsophisticated investors have seen their investments see and saw in a sickening wave motion which gives little comfort or encouragement to invest further.

Compare this then with the S&P or the Dow where record levels are constantly being attained and so  consequently confidence ensues.

So my contention is that the FTSE100 index is both misleading for investors and potentially financially dangerous. Therefore, what should we do?

Well firstly we could replace the FTSE100 plain index with the FTSE100Total Return Index, which includes all the dividends that would have been paid. So this would answer the question – when was the FTSE at it highest? And the answer would be now.

Secondly why don’t we change the make up of the calculation of the index away from the weighted by capital measurement, which mean that the top ten stocks usually account for around 65% of the index. This in effect means that the other 90% of the membership are almost irrelevant and that today’s popular giants lead the way – until the giant trips and falls.

In its place we could create an equally weighted index, such that each constituent member is 1% of the 100 Index.  The effect of this is to create a much smoother ride for the investor and its member companies, and in my view give a much fairer view as to the real value of those companies.

So it’s about time we started a campaign for a fairer FTSE, and then at last those newsreaders will be telling us some more information of value rather than just a fatuous financial fallacy.

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