Ftse 100 index: Meaning, Criticisms & Real-World Uses

What Is the FTSE 100 Index?

The FTSE 100 index, often informally called "Footsie," is a leading Stock Market Index that represents the performance of the 100 largest blue-chip companies by Market Capitalization listed on the London Stock Exchange (LSE). It serves as a key indicator for the overall health and direction of the United Kingdom's equity market, providing a snapshot of the country's largest publicly traded companies. The FTSE 100 is part of the broader financial market indicators and is widely followed by investors, analysts, and the media to gauge economic sentiment and market trends.

History and Origin

The FTSE 100 index was launched on January 3, 1984, with a base value of 1,000. It was created by the London Stock Exchange in conjunction with the Financial Times to offer a more representative measure of the UK's top companies than the previously used Financial Times 30-Share Index. The introduction of the FTSE 100 was crucial for the development of London's new equity Derivatives market, enabling the launch of options and Futures Contracts based on the index shortly after its debut. The index's growth throughout the 1980s and 1990s mirrored the bull market in equities during that period. For comprehensive details on the index and its constituents, the London Stock Exchange maintains a dedicated overview.⁵

Key Takeaways

The FTSE 100 index tracks the performance of the 100 largest UK companies by market capitalization on the London Stock Exchange.
It is a capitalization-weighted index, meaning companies with larger market values have a greater impact on the index's movements.
The index's constituents are reviewed quarterly to ensure they meet size and liquidity criteria.
The FTSE 100 serves as a significant Benchmark for the UK equity market and is widely used for tracking funds and derivatives.
Unlike some total return indices, the headline FTSE 100 index primarily reflects price movements and does not typically include reinvested Dividend income.

Formula and Calculation

The FTSE 100 index is a capitalization-weighted index. Its value is calculated by taking the sum of the Market Capitalization of each of its constituent companies, adjusted by a free-float factor, and then dividing this sum by a divisor. The free-float adjustment accounts for shares readily available for trading, excluding those held by insiders or restricted.

The basic formula for a market-capitalization-weighted index is:

\text{Index Value} = \frac{\sum (\text{Price}_i \times \text{Shares Outstanding}_i \times \text{Free-Float Factor}_i)}{\text{Divisor}}

Where:

(\text{Price}_i) = Current share price of company (i)
(\text{Shares Outstanding}_i) = Total number of shares issued by company (i)
(\text{Free-Float Factor}_i) = The proportion of shares available for public trading for company (i)
(\text{Divisor}) = A numerical value used to maintain historical continuity of the index, adjusted for corporate actions like stock splits or mergers.

The index is calculated in real-time throughout the trading day by FTSE Russell, a subsidiary of the London Stock Exchange Group.⁴

Interpreting the FTSE 100 Index

Interpreting the FTSE 100 involves understanding its movements as a reflection of the collective performance of the largest companies in the UK market. A rising FTSE 100 generally indicates bullish sentiment and economic growth, while a falling index suggests bearish sentiment or economic contraction. As a Stock Market Index, it is often seen as a barometer for investor confidence and the financial health of the UK economy. It is important to note that the index represents large-cap companies, and its performance may not fully capture the trends in smaller companies or specific sectors. Investors often compare the FTSE 100's performance against other major global indices to assess relative market strength or weakness. The index is used as a Benchmark to evaluate the performance of investment portfolios and funds.

Hypothetical Example

Consider a hypothetical scenario where the FTSE 100 index closes at 7,500 points on a Monday. On Tuesday, a major pharmaceutical company (a constituent of the index) announces positive drug trial results, causing its share price to jump significantly. Simultaneously, a large banking group within the index benefits from a favorable interest rate announcement, and its stock also rises. While some smaller index components might see minor declines, the combined positive impact from these larger, heavily weighted companies could push the overall Market Capitalization of the index constituents higher. As a result, the FTSE 100 index might close at 7,550 points on Tuesday, reflecting a broad, albeit weighted, increase in the value of its top companies. This demonstrates how the movements of key Equities significantly influence the index's daily fluctuations.

Practical Applications

The FTSE 100 index has numerous practical applications in the financial world. It is widely used by investors who engage in Passive Investing strategies, particularly through Exchange-Traded Funds (ETFs) and index funds that aim to track its performance. These products allow investors to gain diversified exposure to the UK's largest companies without needing to buy individual stocks. The index also serves as a critical Benchmark for active fund managers who strive to outperform the market. Financial analysts and economists monitor the FTSE 100's movements as a real-time indicator of investor sentiment and economic conditions in the UK. Furthermore, the index underpins a range of Derivatives products, such as options and futures, which allow institutional investors and traders to hedge risk or speculate on the future direction of the UK market. For up-to-date market data and news related to the FTSE 100, the Financial Times provides a comprehensive overview.³

Limitations and Criticisms

While a widely used indicator, the FTSE 100 index has certain limitations and has faced criticism. One notable critique is that the headline FTSE 100 is a "price-only" index, meaning its reported value reflects only the change in share prices and does not account for the reinvestment of dividends.² This can give a misleading impression of long-term returns for investors, as dividends are a significant component of Total Return from Equities. For instance, an article from Timeline highlights how the index's perceived unimpressive price return over decades fails to show the substantially greater total return when dividends are considered.¹

Another limitation stems from its composition; while it represents the largest UK companies by Market Capitalization, many of these companies are multinational corporations with significant overseas earnings. This can sometimes make the FTSE 100 less sensitive to purely domestic UK economic factors compared to other, more domestically focused indices. Additionally, the rules-based approach for adding and removing constituents, based on Liquidity and market value, can lead to predictable changes, sometimes resulting in anticipatory trading around quarterly reviews.

FTSE 100 Index vs. FTSE 250 Index

The FTSE 100 index and the FTSE 250 Index are both prominent UK equity benchmarks, but they track different segments of the market. The FTSE 100 focuses on the 100 largest companies by market capitalization, often referred to as "blue-chip" stocks. These companies tend to be large, established, and often multinational, with a significant portion of their revenue generated internationally.

In contrast, the FTSE 250 Index comprises the next 250 largest companies after the FTSE 100. These are typically mid-capitalization companies, which often have a greater exposure to the domestic UK economy compared to their FTSE 100 counterparts. Consequently, the FTSE 250 is sometimes considered a better gauge of the UK's domestic economic health, whereas the FTSE 100 is more reflective of global economic trends impacting large corporations. Investors may consider both indices for comprehensive Portfolio Diversification across different market segments.

FAQs

What is the "Footsie"?
"Footsie" is a common, informal nickname for the FTSE 100 index, the main stock market index for the United Kingdom.

How often does the FTSE 100 index change its companies?
The companies included in the FTSE 100 index are reviewed quarterly, typically in March, June, September, and December. Changes are based on market capitalization and Liquidity criteria.

Can an investor directly invest in the FTSE 100 index?
No, investors cannot directly purchase the index itself. However, they can invest in products that aim to track its performance, such as Exchange-Traded Funds (ETFs) or index funds, which hold the underlying Equities in similar proportions to the index.

Does the FTSE 100 include dividends?
The widely quoted FTSE 100 index (price index) does not include the reinvestment of Dividend income. However, FTSE Russell also calculates a "FTSE 100 Total Return Index" which does account for dividends, providing a more complete picture of investment performance.

Why is the FTSE 100 index important?
The FTSE 100 index is important because it serves as a key Benchmark for the UK equity market, reflecting the performance of its largest companies. It is widely used by investors, fund managers, and financial analysts to assess market trends, evaluate portfolio performance, and understand the economic outlook.