A fully flexible way to invest
5 minute read
As Centrica teeters on the brink of exiting the FTSE 100, we consider how the index has changed since its inception, and why this matters for investors.
The value of investments can fall as well as rise. You may get back less than you invest. Tax rules can change and their affects on you will depend on your individual circumstances.
Scarcely did an advertising break on UK television in 1986 pass without the now famous “Tell Sid” commercial, inviting the public to invest in a soon-to-be-privatised British Gas. If you had listened to Sid and bought British Gas shares, you certainly weren’t alone.
Roll forward 33 years and today, the company – known as Centrica following its demerger from British Gas in 1997 – teeters on the brink of slipping out of the FTSE 100 Index as a perfect storm of dividend cuts, a government price cap, and the loss of millions of domestic energy consumers have caused the share price to slump by more than half over the last year alone (as at 11/11/19).
Here, we consider how the FTSE 100 index has changed since its inception (on 3 January 1984), and why this matters for investors.
The FTSE 100 is an index of the current top 100 companies by their total share value which are listed on the London Stock Exchange. Each quarter, all the companies in the index undergo a rules-based review. Companies are automatically promoted to the FTSE 100 from the FTSE 250 when they rank within the top 90 companies in the UK in terms of value. Firms are automatically ejected from the FTSE 100 if they fall outside the top 110 largest companies. This prevents stocks from constantly dipping in and out of either index at each reshuffle.
When the FTSE 100 launched in 1984 it was full of home-grown talent, including household names such as Tesco and Boots, British Aerospace and British Petroleum. If you wanted exposure to the expanding UK economy, an investment in the FTSE 100 was your first logical step.
But times have changed.
Today, just 28 of the original 100 companies remain listed in the index. Mergers, promotions, demotions and new listings have seen UK-focused businesses replaced by global companies. This has changed the FTSE 100 from a UK-focused index to one that represents the wider global economy.
Investing in the FTSE 100 is no longer an accurate indicator of the UK’s corporate health. Global companies, such as Royal Dutch Shell and GlaxoSmithKline, now make up a significant portion of the index and all generate significant sales overseas. Despite ninety-seven percent of companies being based in the UK, only 29% of revenues are generated here.
If you want a better reflection of the UK economy, companies listed on the FTSE 250 Index generate 55% of their revenues in the UK (according to FactSet).
Why does this matter? Well, investing in the FTSE 100 does not necessarily mean you’re investing in the UK, which is important if you’re trying to build a diversified portfolio which is balanced across geographic regions. Also, FTSE 100 companies who earn revenues overseas are subject to currency movements. A strong euro can be good for UK companies that earn their money in euros as those same euros will buy more pounds when translated back into sterling. However, the opposite is also true.
As the index has evolved so too have the corporate sectors which dominate it. Over the last ten years, consumer staples (these are essential products that include food, beverages, household goods etc.), and healthcare have made big gains in their make-up of the FTSE 100. The financial sector, made up largely of banks and energy stocks, are still among the biggest components but their importance has diminished over the last decade.
One of the reasons that membership of a particular index matters is the way in which passive funds adjust their portfolios on the back of the quarterly changes. This is particularly the case with the FTSE 100 index which is the key benchmark for many UK tracker funds. By definition they can only invest in members of that index and they are forced sellers of relegated stocks.
This helps explain why the negative impact of ejection from an index is so much greater than the positive boost provided by inclusion. Relegated stocks are likely to experience hard times after the demotions are announced because funds that track the FTSE 100 will be forced to sell their holdings. However, once the reshuffle is complete, the shares may move higher in some cases although this is not guaranteed. Each case is dependent on individual circumstances. The expertise of fund managers in building and adjusting active portfolios can help amid this constant flux.
Smart Investor offers a wide range of funds across a wide range of sectors, which can help you to build a diversified portfolio. Our Barclays Funds List may help you to narrow down the wide range available to invest in. These funds are selected by Barclays investment specialists and, based on our research, they’re the funds that we believe have the potential to generate consistent returns over the medium to long term.
If you’re looking for funds which invest in the UK share market, the Lindsell Train UK Equity Fund (accumulation units) and the Merian UK Alpha Fund (accumulation units) are just two options worth considering. Equally, there may be other funds which may be more appropriate for you.
These funds are designed for the long term so you should only consider them if you can stay invested for at least five years.
All of these investments can fall in value as well rise; you may get back less than you invest. We don’t offer personal investment advice. If you’re unsure whether an investment is suitable for you, you should seek independent advice.
These are our current opinions but the future, as ever, is uncertain and outcomes may differ.
The value of investments can fall as well as rise. You may get back less than you invest. Tax rules can change and their effects on you will depend on your individual circumstances.
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