Every quarter, two or three under-performing constituents drop out of the FTSE 100 index and are replaced. As in the Premier League, it seems that most of those who exit soon return, and most of those who are promoted depart a few quarters later. Only the takeover victims disappear for ever.
Over time the changes build up, and the FTSE 100 has changed a great deal since it was first constructed 22 years ago. The combined market value of the initial 100 companies was just over £100 billion and the index was based at 1,000. It briefly dropped below 1,000 in mid-1984, and reached a peak of 6,930 at the end of 1999.
The largest one day moves, up and down, were on consecutive days. On the 20th October 1987, the FTSE 100 index fell 12.22%. The next day, it rose 7.89%. Volatility has probably been reduced by futures trading, whose volumes have multiplied over 250 fold-since 1984.
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With the index near 5,600, the compound annual advance is 8.1%, but the total value of the index has increased to over £1,400 billion, a compound increase of 12.7%.
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Only 62% of the annual increase in the market value is attributable to share price appreciation: the rest is down to share issuance. The advance of the mega-cap increased the FTSE 100's share of the All Share index from a little over 60% to a peak of well over 80% in the late 1990s. It is now on the way back down, not only because smaller companies are out-performing but also share buy-backs and cash takeovers have resulted in the market shrinking for the last two years.
Investing in the FTSE: admission criteria
It now takes a market valuation of £2.5 billion to gain admission to the FTSE 100. In 1984, £100m of market value was enough for admission, and £2.5 billion would have taken a company to just outside the top five.
The largest two companies are the same, but BP's market value has multiplied 18-fold along the way to £134 billion and Shell's 19-fold to £124 billion. In 1984, BP was still 50% owned by the government, while Shell, as well as its 40:60 dual listing with Royal Dutch, had a quoted subsidiary in the US, Shell Oil.
Along the way, BP acquired Sohio, Amoco, Arco (Atlantic Richfield), Britoil and Burmah, which had been its founding outside shareholder in 1905. Burmah still owned 25% of BP until a financial crisis in 1974 led to one of those "bail-outs", like British Energy, from which only the Government and its advisors benefit. Shell absorbed its US subsidiary and Royal Dutch share class but also acquired Enterprise.
The third largest company in 1984 was GEC, which acquired fellow FTSE 100 constituent Plessey before disappearing in a puff of smoke many years later as Marconi. ICI, number four in 1984, was a chemical giant, with divisions in pharmaceuticals (spun out as Zeneca) and oil (sold to Enterprise). Marks and Spencer, number five in 1984, hadn't yet moved into food and sourced domestically more than 90% of the clothing it sold.
Investing in the FTSE: an ever-changing index
Only 23 of the original FTSE 100 companies have been there throughout. A further three (Aveva, RSA, and Glaxo) each represent the merger of two 1984 constituents, while Diageo was formed from the merger of Grand Metropolitan and Guinness, which controversially acquired Distillers, a 1984 constituent, in 1986.
A further 11 companies dropped out, but have climbed back in, including Imperial, which was first acquired by Hanson, then de-merged again; and P&O, now disappearing, probably permanently.
Privatisation accounts for 15 of the present constituents, though the number is in steady decline. In 1984, there were only three privatised companies in the FTSE 100; Britoil, British Aerospace and Cable & Wireless, which was then the only telecom company in the index.
A similar number of companies have been floated on the market from private hands; from demutualization issues like Alliance & Leicester, Alliance Unichem and Northern Rock to the most recent high flyers', Partygaming and Kazakhmys. Some of the names such as Reuters- would have been familiar in 1984, others such as Man Group - barely known, and a few such as Cairn and BSkyB totally unheard of.
Nine present constituents are refugees from overseas, including six from South Africa. US-based Amvescap acquired its listing when it bought Invesco (formerly the investment division of Samuel Montagu, part of Midland Bank), and HSBC when it bought Midland Bank. Antofagasta was always listed in the UK, having been a railway company until the early 1980s, but has never had any business interests here.
Partygaming and Kazakhmys are also refugees, but were never listed elsewhere. With at least four Russian companies lining up for flotation, London is well on its way to joining Panama and Liberia as a "flag of convenience" location. Many of the 1984 constituents derived a majority of their earnings from overseas, but the tax system encouraged them to have a significant UK business and their nationality was not in doubt.
A few current constituents, including British Land and Smiths, were significant FTSE 250 companies in 1984. Others have evolved tortuously: Vodafone was spun out by Racal, who were much criticised in 1984 for pouring money into the limited' market for mobile phones. ITV was then 15 different companies, of which Granada was one of the larger regions. Princess Cruises was de-merged from P&O before it merged with Carnival. Compass and InterContinental were both divisions of Grand Metropolitan as was, briefly, the recently demoted William Hill.
There are relatively few companies which have climbed from smaller company to the FTSE 100 through organic growth. They stormed into the FTSE 100 in the TMT boom, but many aren't even in the FTSE 250 any more. The few surviving rags-to riches stories include Sage, Capita, and Next.
Next was launched as an experiment by the ailing J. Hepworth chain in 1982, with just four shops. It over-expanded, nearly collapsed in the early 1990s, and then recovered. WPP has its origins in a company which once made supermarket trolleys, and which Martin Sorrell took control of when he left Saatchi's. The companies he acquired, notably J. Walter Thompson and Ogilvy & Mather, were familiar names in 1984.
Many of the index veterans have, in fact, changed radically in the last 22 years. Reed and Pearson are no longer conglomerates; BAT has lost its financial services and retailing arms; and Whitbread and Scottish & Newcastle no longer brew beer. Dixons at least changed its name (to DSG) to reflect the change in its business.
No fewer than 40 of the original 1984 constituents have disappeared through takeovers and a further seven were absorbed into mergers. Others, including Bass, Racal and Thorn EMI, were radically restructured with some of their offspring being subsequently bid for. In 1984, bids from overseas were rare. The auction for Sotheby's between two American buyers in 1983 did not lead to the expected surge in overseas bids. Rowntree was bought by Suchard and then Jaguar by Ford, but it is only in the last 10 years that takeovers from overseas have become commonplace.
Investing in the FTSE: notable casualties
At first glance, it seems reassuring that few of the original constituents actually went bust only Ferranti and British & Commonwealth. Polly Peck and Maxwell Corporation entered the FTSE 100 along the way and then went bust, but most of the FTSE 100 disasters didn't collapse so spectacularly. More common has been a long tortuous decline or a financial collapse followed by restructuring and zombie-like survival.
Coats Viyella went from FTSE 100 to small cap in just a few years, and was then taken over. Eurotunnel had a market value in the billions when its share price rose above £10, but may not have actually been in the index. Railtrack and British Energy were sabotaged by the present government; in the former case shareholders eventually retrieved some 20% of the peak share price. In the latter the shares are still down more than 90% from the peak although the company is on the verge of re-entering the FTSE 100.
BTR rose from small beginnings to be one of the largest companies in the market through the acquisition and subsequent rationalisation of underperforming companies. In 1984, it had just taken over Thomas Tilling, probably its best deal, and it went on to acquire Hawker Siddeley, a fellow FTSE 100 company. Its star was very much on the wane when it later merged with the equally acquisitive Siebe. The resultant company survives, just, as Invensys.
Dalgety, Trafalgar House and Sears have become almost forgotten, but these 1984 constituents also destroyed most of their shareholders' money before putting them out of their misery by accepting bids which would have once looked derisory.
Investing in the FTSE: anything but a 'blue-chip' index
The effect of all these changes on the sector composition of the FTSE 100 has been dramatic. Industrials accounted for 25 of the original constituents, but only 3 now. Surprisingly, consumer constituents have fallen from 31 to 19. The resources and financials sectors have grown, but the biggest increase has been in services, with 24 constituents against 7 in 1984. After all the bright hopes of the TMT boom, there is still only one constituent from the technology sector, Sage, and its position is far from secure.
The lesson for the investor is that the apparent permanence of the FTSE 100 is an illusion. The FTSE 100 is like Space Invaders: how ever many get zapped, there will always be replacements crowding in from behind. Some of those that disappear in takeover bids do so in glory, leaving their investors well satisfied, but others slink off when well past their prime. Unlike in the US, very few companies have achieved top 100 status through organic growth or technological innovation. Equating membership of the FTSE 100 with "blue chip" status is and always has been a non-sequitur.
Globalisation has left the FTSE 100 in limbo. The FTSE 100 does not represent the best of British companies, but it does not have the breadth or spread of the global indices either. It does not capture the growth opportunities of other markets and investment in it is not low risk. There are two ways investors can respond to this; they can invest in UK funds which are totally unconstrained by the make up of the index or they can abandon parochialism and invest in global funds.
By Max King, strategist at Investec
