The FTSE 100, as the most widely followed FTSE index, represents the share price performance of the largest 100 UK-listed companies by market capitalisation.
It is just one of many FTSE indices that constitute the shares of UK-listed firms. In all, there are thousands of other FTSE indices, many of which track the performance of shares quoted overseas.
What is FTSE index?
The FTSE brand name was previously jointly owned by the Financial Times newspaper and the London Stock Exchange. Today, it is wholly owned by the London Stock Exchange through its subsidiary, FTSE International Limited.
While the FTSE 100 was launched in 1984, it was long preceded by the inception of the FTSE All Share index in 1962, or the FT Actuaries All-Share as it was then called.
The FTSE All Share is still thought of as a strong performance measure for firms listed in London; it comprises well over 600 companies, which together represent 98% of the UK´s market capitalisation.
The launch of the FTSE 100 in 1984 was followed by the inception of the FTSE 250 in 1992. As its name suggests, this latter represents the share prices of the largest 250 UK-listed firms by market capitalisation. Among the other UK FTSE share indices are the FTSE 350 and the FTSE SmallCap.
FTSE 100: closely watched
While having far fewer members than the FTSE All Share, and representing around 80% of the UK´s market capitalisation, the FTSE 100 is much more closely watched.
As a general rule of thumb, the firms listed in the FTSE 100 index tend to be relatively global in nature, deriving a significant amount of their revenues from abroad.
Meanwhile, the performances of the FTSE 350 and FTSE SmallCap tend to be much more related to the underlying strength of the UK economy. This is because smaller UK-listed firms are generally more dependent on the UK for their revenues versus the blue-chip names in the FTSE 100.
The upshot is that the FTSE 100 tends to benefit from weakness in the pound.
Should sterling fall in value, many of the firms in the FTSE 100 will see their profits in sterling terms increase. They would receive more pounds when revenues denominated in foreign currencies are converted into sterling.
The FTSE 100 is calculated in real time, with the index level published each second that the London stock exchange is open – the trading day begins at 08:00 and ends at 16.30.
As with all the FTSE indices, share prices are weighted by market capitalisation. Using this methodology means that the larger companies make more of a difference to the index level than the smaller constituents.
Global by nature, the FTSE 100 tends to rise and fall along with worldwide equity markets in general.
Peaks and troughs
When the FTSE 100 was incepted in January 1984, its base level was 1000. By the end of 1999, during the final throes of the dot-com boom, the FTSE 100 had climbed to 6,930.20.
With the bear market that followed the earlier exuberance, by March 2003 the index had plunged to 3,491.59.
Prior to the beginning of the financial crisis in 2008, the FTSE 100 had still not recovered to its previous high of 1999. The index reached a peak of 6,732.40 in June 2007, but slumped to 3,530.73 in March 2009 as the ensuing financial crisis took its toll. This was just shy of the trough reached some six years earlier.
The index is currently hovering around all-time highs; since the financial crisis of 2008/2009, global equity prices have been pushed higher by low interest rates and quantitative easing measures. On 26 May 2017, the FTSE 100 reached an all-time closing high of 7,547.63.
In general, small and mid-cap stocks are viewed as being riskier than their large-cap counterparts.
Larger companies are often in a strong position from a trading perspective in their respective markets as well as tending to have more robust balance sheets. During the financial crisis, both the FTSE 250 and FTSE SmallCap fell further and faster than the FTSE 100.
However, this characteristic also means that smaller-cap shares can outperform the blue chips on the upside, especially when investor risk appetite is buoyant. Over the past five years, the FTSE SmallCap and FTSE 250 have risen by 122% and 116.5% respectively. During the same period, the FTSE 100 has advanced by 70.4%.
At the same time, the FTSE 100 isn´t necessarily less volatile than the smaller-cap indices at any given point. With just 100 names, the index is relatively concentrated.
Over five years, based on monthly data, the FTSE 100´s volatility is 10.1%. This compares with 9.8% and 8.2% respectively for the FTSE 250 and FTSE SmallCap. The latter incorporates around 270 stocks.
Changing of the guard
Intuitively, no one company should be expected to grow forever. Even some of the largest businesses in the world may begin to contract once they reach a mature phase in their life cycle.
There is also the impact of mergers and acquisitions (M&A) activity, which can see certain groups within the same index merged together.
Others may disappear altogether from the index, if for example they are acquired by a company based overseas.
In order to ensure that the index remains up to date and relevant, the FTSE 100 is reshuffled every quarter. The reshuffle often sees certain names relegated, though they typically remain within the FTSE 250.
Other names may see themselves promoted to the big league, gaining a prestigious place in the FTSE 100 for the first time. Some firms can also find themselves moving back and forth over time, regaining their place in the top tier after having been previously relegated.
Firms are banded through a rankings system, so that firms breaking through into the top 100 are more likely to stay there for a reasonable amount of time. A FTSE 250 firm must therefore have risen into the top 90 companies to be promoted into the FTSE 100.
On the way down, a FTSE 100 firm must have fallen to the 111th place in the rankings or lower to be relegated into the FTSE 250.
Promotions and relegations
The quarterly FTSE reshuffle can provide a snapshot of which companies are experiencing a change in fortunes for the better and which may be experiencing some deterioration.
Some analysis of the underlying fundamentals, perhaps using firms´ most recent financial statements, could also help us to decide how persistent any such evolving trend is likely to be.
Promotions and relegations may also be indicative of wider macroeconomic conditions. For instance, there has been some impact from the shock result in last year´s referendum on EU membership and the resulting decline in the value of the pound.
With the Brexit vote, we have seen some rotation away from companies more reliant on the UK´s domestic economy, in favour of those more exposed to global markets. While the FTSE 100 was already very globally orientated, the Brexit vote has seen the index become even more global in its makeup.
Among the firms recently promoted to the top tier are pest-control company Rentokil Initial. Given the global footprint of its business, with its exposure to revenues denominated in US dollars and euros, Rentokil was boosted by the sharp fall in the pound following the referendum.
Meanwhile, more domestically orientated firms were hurt by the uncertainty surrounding Brexit and the long-term worries over its impact on the UK economy. Against this backdrop, housebuilder Berkeley was among the firms relegated from the top tier.
The FTSE 100 index is one of the most important and widely followed indices in the world. While promotions and relegations may give us clues to underlying business and economic trends, the index should not be viewed as a reliable indicator on the outlook for the UK economy.
FTSE 100 companies tend to be global in nature and much more impacted by worldwide economic and geopolitical conditions rather than those specific to the UK.
At the same time, the FTSE 100 tends to have a negative correlation with sterling. With their underlying businesses being global by nature, many FTSE 100 companies tend to benefit when other major currencies strengthen versus the pound.