Ben Kumar, Investment Manager, Seven Investment Management
In finance ‘footsie’ means something other than tangle-toed flirting. The FTSE 100 is the first stock index encountered by newcomers to the world of finance. It is often described as a “group of the shares of the 100 biggest companies listed on the London Stock Exchange” – and that’s not a bad explanation. However, it isn’t the full picture.
The FTSE 100 level is used by almost everyone to give an indication of how all the UK stock markets are performing. People celebrate when it overcomes milestones such as previous highs, or nice round numbers like 7,000; and people get worried when it falls sharply as investment can do. But why do people react? It’s due to a bit of everyday mental magic that humans perform – attribute substitution1. Simply put, we tend to treat the FTSE 100 as a proxy for the well-being of the UK economy.
You can see why. The UK economy is a kind of blurry concept, with loads of moving parts that can’t be easily monitored at any single moment in time. The FTSE 100, on the other hand, offers a handy number that updates every day, can be used to make historical comparisons, and (perhaps best of all) is calculated by someone else. We see similar simplifications all over the world. The US investors monitor the Dow Jones or the S&P 500, Japanese investors watch the Nikkei, and Chinese investors track the Shanghai Composite.
This approach is imperfect, but we assume it is close enough. The blurb on the back of a book won’t tell you the whole story, but you’ll know whether you’re reading a romance, a fairy tale or an economics textbook.
Unfortunately, if you’re looking for a tome on the UK economy, the FTSE 100 is the wrong synopsis2. The five largest businesses are a banking conglomerate, two oil companies, a tobacco company and a pharmaceutical company. In front of all of those descriptions, you should put the word ‘global’. HSBC, BP and Royal Dutch Shell make 65% of their money outside of Europe. British American Tobacco, despite the name, makes more than 85% of its sales outside of the UK, and GlaxoSmithKline is similar.
At a broad index level, just 29% of the FTSE 100’s total revenues come from the UK. In the US, that number is 67%, Japan 63%, and China is above 80%. Sometimes investors look to the FTSE 100’s smaller cousin, the FTSE 250 – an index composed of the next 250 largest companies in the UK. Even here though, just 50% of revenues come from the UK. That’s still a way off the level in other nations.
The important thing is to understand what an index is telling you. The FTSE 100 isn’t bad – not least as an index doesn’t really deal in any moral questions pertaining to good or evil – but it doesn’t do a good job of representing the UK economy. Something to bear in mind when the headlines hint at hysteria…
1 This idea of switching a difficult concept for an easier one is maybe the most fundamental human behavioural error. Daniel Kahneman explores this in a very readable fashion in Thinking, Fast and Slow.
2 My favourite terrible synopsis is of The Wizard of Oz. “Transported to a surreal landscape, a young girl kills the first person she meets, then teams up with three strangers to kill again.”
