Scrap the FTSE 100 for an index that reflects British business

The one thing the City is really good at is constant re-invention. The UK economy may be in ropey shape, the euro about to implode, and the economies of the West in danger of being permanently eclipsed by the rising economic powers of Brazil, India and China, but London is emerging as the stockmarket of choice for many of the world's resources giants. It is in the City where their shares are listed and traded, and it is the City bankers who rake off the fees from raising capital for them.

The last month alone has brought news of two more huge resource companies that will soon be FTSE companies. The Swiss commodities trader Glencore is planning a float in London. With a likely market value of £31bn, it will vault straight into the FTSE 100 index. So will Vallar, Nathanial Rothschild's acquisition vehicle, following the reverse takeover of Indonesian coal-mining company Bumi. It's great, of course, that so many global companies choose London as the place to list their shares. There is a snag, however, and one that needs more debate. The FTSE 100 is the benchmark index for the British economy. And yet, increasingly, it has absolutely nothing to do with the UK.

Both Glencore and Vallar will have plenty of company when they join the FTSE, which is probably one reason why they chose to list here. The FTSE is home to a whole crop of resources companies, many of them very substantial businesses. African Barrick Gold was spun out of the Canadian gold miner Barrick Gold earlier this year and now has a value of £2.3bn. Kazakhmys, the Kazakhstan copper producer, has a value of more than £8bn. Xstrata, the Swiss-based mining conglomerate, has a value of more than £40bn. Together with businesses such as Vedanta Resources, an Indian-controlled company, Randgold Resources, Anglo-American, Rio Tinto and BHP, resources companies are increasingly the dominant force in the FTSE. If we count BP and Shell as commodities companies, that is even more true.

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Of course, the FTSE has always been a very global index, and rightly so. Companies such as Glaxo, Barclays, and Unilever are all multinational businesses. Only a relatively insignificant part of the sales are in Britain. While they are all dependent on the global economy, they are all recognisably British companies, with their roots in this country. They are, to a fairly high degree, a good measure of how well the UK is doing in the world, and how strong our industrial base is. While that is true of some of the resources companies Rio, for example, or BP it clearly isn't true of most of the newer ones. In short, in contrast to, say, the French CAC index or the German Dax, the FTSE has lost all touch with either the British economy or the UK's industrial base.

That matters more than you might think. The FTSE is used as a benchmark of how well the UK and the stockmarket are doing. It is the single figure we hear quoted on the radio every day. For investors, it is the main measure of how their investments are doing. It is what pension funds and unit trusts largely track. In a subtle, but significant way, it shapes where capital gets invested. But it doesn't make much sense for everyone to follow the progress of what is, increasingly, a fairly random collection of global mining companies.

No one is suggesting that anyone should be discouraged from listing in London. No one wants to stop Glencore or Vallar from having its main quote there. What the stock exchange should be doing instead is coming up with a new index that reflects the British industrial base more accurately, and making sure that is used as the benchmark for the UK stockmarket.

That isn't going to happen by accident. You could take the FTSE 250 as a more accurate measure of the UK economy, but while that would have some merits, it doesn't make much sense to have an index that leaves out AstraZeneca or Tesco. Only a new index will do. But how should that be constructed?

For starters, it should probably be a lot smaller. The CAC 40, rather obviously, has only 40 members. The Dax is made up of just 30 companies. When you have a hundred members, it is quite easy for companies to flit in and out of the index. Getting into the top 30 or 40 companies is a lot harder.

Secondly, you could restrict the turnover of members. The FTSE's membership is updated four times a year. It is a size-based measure. If you are big enough, you are in. But it doesn't have to be that way. In the US, for example, the Dow Jones Index is not only restricted to just 30 companies, it hardly ever changes. Admittedly, that creates some oddities of its own. Microsoft and Intel didn't join the Dow until 1999. But because it has only changed its membership 48 times in its 114-year history, the Dow is a far more representative measure of the core of the American economy than the FTSE now is.

There would be lots of ways that a British version of the Dow could be designed. And we could all have fun arguing about which companies should be in it. But one thing is clear. The FTSE 100 isn't a useful index for the UK and should be replaced as fast as possible.

This article was originally published in MoneyWeek magazine issue number 516 on 10 December 2010, and was available exclusively to magazine subscribers. To read all our subscriber-only articles right away, subscribe to MoneyWeek magazine.