Paul Lewis: The unexplained quirks of the FTSE 100
By Paul Lewis
I got into big trouble last week. I only tweeted a few numbers, then a simple sum. But here is what I did wrong. The numbers were the FTSE 100 and if one thing turns off the anger management software in a financial adviser’s breast it is that. I was treated to several mini-essays (you can get a lot in 280 characters) about what a rubbish index it was.
It was in the news because around the world share prices, at least as measured by indices such as the Dow Jones Industrial average (30 firms and an odd way of combining their data), had plunged to their lowest level since, well, since a very short time ago. We were told the Dow had a record one day fall. That was true in points but not in percentage terms, which is all that really matters.
The 10 per cent fall over nine trading days was fairly routine, a correction not a crash or anything to be worried about. Unless of course you had, on advice, invested a chunk of your hard earned just before the, ahem, correction. Which the professionals told us was inevitable even if they didn’t know – except afterwards – that it would happen that week.
"A time when a monkey with a pin could make a profit"
Anyway, in my tweet headed ‘This is not about investment’ I had the temerity to look a long way back, first to 31 December, 1999 where there was a definite millennial peak. Then to 1 January, 1984 when the FTSE 100 was born. That was 16 years before the millennium and from then to now was a shade over 17 years.
Now, I recall the last quarter of the last century as a time when share prices only went one way – up. The new index called FTSE 100 started at 1000 on 3 January, 1984 and ended its first 16 years at 6930, rising in a wrinkly straight line at a compound rate of 12 per cent a year. It was the glory time when a monkey with a pin could make profitable investment decisions and often did. The credit, of course, was taken by the star fund managers, along with big chunks of returns which investors – still making 7 or 8 per cent a year – did not notice.
This side of the millennium was also a period when share prices only went one way – all over the place. And when the FTSE 100 closed at 7141 on 6 February, it was just 3 per cent higher than where it closed the 20th century. That is a compound annual rise of just 0.19 per cent. Of course over that time it went up and down like a sash window in spring, plummeting three times – most recently by 22 per cent in the 10 months to February 2016.
The graph of the FTSE 100 from 1984 to the end of 1999 shows it was on a clear upward 16-year trend, if slightly exaggerated by what we now call the dotcom bubble. It was very different from the peaks and troughs and three major falls in the next 17 years.
I drew no conclusions. I just did the arithmetic and wasn’t even ducking when the volley began. The first missile was why did I not include dividends? Was I really so stupid that I didn’t realise investment returns depended on dividends? The FTSE 100 with dividends reinvested is the FTSE ‘total return’ or TR index. But it is no better a guide to what an investor would make than the bare FTSE 100. The TR does not make any deduction for the costs and charges taken from real investments. So it exaggerates investment returns.
Even in a tracker those charges can be significant and, as Mifid II has shown, largely hidden. In the closet trackers that pass for many actively managed funds they are even higher and will eat away much of the dividends before they are reinvested. The bare FTSE 100 may be an underestimate of real investment returns but the TR index is certainly a great overstatement.
"An index of totally different companies"
Then came the grape shot. Did I not realise what a meaningless, poor, unrepresentative, narrow index the FTSE 100 is? Many of its members are focused on business abroad so share values goes up and down with sterling. Every quarter two or three companies leave and two or three join. So historically it is an index of totally different companies.
Then the kick in the head – why not use the FTSE 250 which represents UK companies and the UK economy better? Or the FTSE All Share, ditto? It did not matter how many times I said this was not about investment, but about the FTSE 100 index of shares in the biggest hundred companies listed on the London Stock Exchange. The fall in that was leading the bulletins. Endless investment professionals who had warned that the price of shares can fall as well as rise were asking if this was the major correction they all remembered they had long been predicting. It wasn’t of course, at least not so far.
So I did the numbers. If the FTSE 100 had risen in the last 17 years as it did in its first 16 it would now be 48,027. Put another way if the FTSE 100 index had grown in its first 16 years as it did in the last 17 it would have closed the 20th century at 1030 not 6930. Whatever you think the FTSE 100 is or represents those numbers are interesting. And so far unexplained.
Paul Lewis is a freelance journalist and presenter of BBC Radio 4’s ‘Money Box’ programme. You can follow him on Twitter @paullewismoney