The changing face of the FTSE 100

Edward Menashy, chief economist at London stockbrokers Charles Stanley, thinks the FTSE 100 index - sometimes called the Footsie - is an index of shares "at the wrong address".

In the public mind, it is a measure reflecting what is going on in the UK economy. In reality, more than 70% of the profits of the companies that make up the top 100 share index come from abroad. The index consists entirely of companies quoted on the London Stock Exchange, but there is nothing particularly British about many of these companies.

Menashy says: "A number of companies - particularly in the mining and natural resources sector - have no UK activities at all." He is thinking of Fresnillo, the Mexican silver miner, Antofagasta, the Chilean copper miner, and Kazakhmys, another mining giant based in Kazakhstan.

Many more FTSE 100 companies - including oil groups Shell, BP and Tullow Oil, together with multinationals such as British American Tobacco, Unilever and Glaxo SmithKline - derive the lion's share of their business overseas.

In the days before the FTSE 100 was launched back in January 1984, we relied on an index called the FT 30. It still operates in the same basic way as it has since its inception in July 1935 and more accurately reflects our own domestic situation.

One major difference between the two indices is the way the constituent companies are treated. Once a company is in the FT 30, it is only likely to be removed because it goes bust or is taken over. There have certainly been quite a few failures and plenty of takeovers, and such events affect both indices. But once a company enters the FTSE 100 list, it faces a real fight to stay in this premier league of companies.
Qualification for entry into the FTSE 100 depends on stockmarket capitalisation - at present the lower limit for entry is around the £2 billion mark. The constituents of this index are reviewed every three months, and as many as 10 companies can be relegated from the list or promoted to it.

As a result, the FTSE 100 has been rapidly evolving since its inception. Only companies listed in the FTSE 100 survivors table remain in the index from the original starting list - just 26 companies.

Overseas focus

Menashy believes the trend towards companies with an overseas focus that has developed in recent years is likely to continue. He foresees the FTSE 100 "becoming less and less representative of the UK economy.

"The story of today," he says, "is the story of the emerging markets. Collectively, developing markets are the major force in economic activity - south Asia and India in particular, but South America and eastern Europe as well.

"That is why demand for raw materials is high. These countries are developing their infrastructure and they need basic materials. Strong demand for these materials is going to continue."

He foresees more mining companies coming to the London market to raise capital. London's expertise in this arena is beyond doubt. Already, mining and oil companies collectively represent almost one third of the total value of all stocks in the top 100.

The FTSE 100 is likely to have a new oil entrant soon in the form of HeritaGE, with the merger of UK-based Heritage Oil and Turkey's Genel Energy. It will rival in size the two existing mid-ranking FTSE 100 oil shares Tullow and Cairn.

Colin McLean and Margaret Lawson, who founded SVM Asset Management back in 1990, jointly run the SVM UK 100 Select Fund. McLean finds himself much in sympathy with Menashy's global perspective on the economy and clearly thinks the index is a rich source of opportunity for pursuing that strategy.

The fund's portfolio was recently 52% in resources shares (oil and mining), and mining shares such as Xstrata, Vedanta and Kazakhmys made up 26% of the portfolio companies compared with 11.6% of the underlying index.

"The prospect of more rapid growth in emerging markets and the possibility of sterling coming under further pressure in the currency markets will encourage investment in stocks with greater overseas earnings," McLean says. "Look at a company such as Prudential, where overseas earnings have held up well, while UK earnings have weakened.

That must encourage investors and companies to become exposed to more dynamic markets than our own. The FTSE 100 has always been a very cosmopolitan index and it seems to be becoming more so. I think the trends we have seen lately will carry on."

The FTSE 100 reflects the UK's weakening manufacturing base and its failure to create large companies in the technology sector. Autonomy and Inmarsat are the only obvious technology shares in the FTSE 100.

Invensys, a company that only recently got back into the FTSE 100 and would still be dwarfed by European engineering giant Siemens, actually represents a large part of what is left of UK engineering. The UK has no information technology companies to compare with Apple, Google, Cisco Systems, Oracle, Intel or Microsoft.

McLean reminds us that Invensys actually represents three former constituents of the FTSE 100: Siebe, BTR and Hawker Siddeley.

It is only in telecommunications - with the growth of companies such as Vodafone - and in software - with companies such as Sage - that UK plc has made an impact. Notably, the SVM UK 100 Select Fund portfolio contains no technology companies and no telecommunications companies at the moment.

Ben Rogoff, who runs the Polar Capital Technology Trust, says: "European technology in general has done a pretty poor job of reinventing itself in the aftermath of the dotcom bubble. We had high hopes for alternative energy as a new source of growth, but that seems to have failed to flower."

New contenders

There are, however, some interesting companies in the lower reaches of the market that have a good chance of joining the FTSE 100 in future.
WHEB Asset Management launched a new WHEB Sustainability Fund in June, run by Nicola Donnelly and Clare Brook, whose aim is to provide long-term capital growth by "investing globally in the most compelling growth themes of the 21st century: climate change, water and demographics".

Their colleague Ted Franks admits, though, that companies in this area that might make the big league are few and far between, and at the moment only 13% of the fund is in UK shares. "We think WS Atkins, the engineering consultancy, could make it, as could the environmental consultancy RPS Group," he says.

"We also think some major UK companies are developing into green companies such as Scottish & Southern and the emergency power supply group Chloride."
Meanwhile, Rogoff finds it hard to visualise new technology names coming to the fore with sufficient momentum to get themselves back into the FTSE 100. "ARM is the one with definite potential. The growth rate of the company is double-digit, based on smart-phone demand." Micro Focus and Logica are other possible entrants.
Rogoff bemoans the failure of UK technology companies to position themselves for exciting new technology themes such as mobile data. "The one positive note is that in the past the arrival of technology companies on the FTSE 100 has usually been an indicator that a technology boom is about to come to an end," he says. "That certainly happened the last time there was a rush of technology companies into the index."

Takeover trend

One reason why the make-up of the FTSE 100 has changed so much over the 25 years has been the willingness of government and the corporate sector to allow overseas bidders to come in and absorb some of our leading businesses.

There is a long list of famous UK names that have disappeared from the FTSE 100 because of a foreign takeover. In recent years, ICI, Alliance Boots, Blue Circle, O2, Scottish Power, Pilkington, Corus, BAA, BOC, P&O, Exel, BPB, Allied Domecq and Abbey National have all given up their FTSE 100 status because of a successful overseas bid.

More such bids may be on the way. The consumer sector could well become a target. J Sainsbury has already experienced the hot breath of a predator on its corporate neck. Cadbury, with its wealth of global brands, may not survive much longer as an independent, and troubled British Airways' days of independence may be numbered.
Meanwhile, after the successful acquisition of Friends Provident, Legal & General and Standard Life could soon be the next bid targets in insurance. Roger Nightingale, economist at the Pointon York Group, believes there will be far fewer quoted insurance companies in a few years' time.

He says: "As well as the problems they have with the stockmarket and pension funds, they face a steady draining away of general insurance business from the corporate sector, which is bent on using offshore tax havens to arrange cover for risks."

House builders such as Barratt and Persimmon were summarily booted out of the index, following the slump in the housing market. With the sector now showing signs of revival, it may not be long before there is a house-building representative in the FTSE 100 once again.

This article was originally published in Money Observer - Moneywise's sister publication - in October 2009

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