FTSE 100 at 40: fighting fit or feeling friendless?

It is often mentioned that the previous record closing high of 6,930 in 1999 around the time of the dot.com frenzy was only eclipsed in 2015. It wasn’t until February 2023 that the FTSE100 passed the 8,000 barrier for the first time. On the face of it, that is a paltry return in terms of the index number itself.

It is also only part of the story. The index is reshuffled on a quarterly basis, usually resulting in two or three stocks being relegated and replaced by stocks from the FTSE 250. As such, the share price return in isolation is something of an apples and pears comparison between 1999 and 2023.

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Rather more importantly this does not include the power of compounding, or reinvesting dividends. The UK has traditionally been a generous payer of dividends, and when these are taken into account the figures are startling. Since the turn of the century, the “simple” return - this only considers the index level - on the FTSE 100 is around 12%. However, with dividends reinvested, the total return leaps to 163%.

The power of compounding is even more compelling over greater periods of time, such as going back to 1984 when the index was launched. An investment of £1,000 would now be worth £7,700 on a simple return basis, but over £22,500 in total returns. The importance of a longer-term investment time horizon and the benefits of compounding are plain to see.

UK stocks are out of favour

That said, there is little doubt that the index is currently out of favour with both institutional and overseas investors, propelled by a negative reaction to Brexit from which the UK as an investment destination has failed to recover.

In a time of excitement in high growth stocks, particularly US technology shares where the potential for artificial intelligence (AI) has led the so-called “Magnificent Seven” to stellar returns, especially last year, the FTSE 100’s lack of obvious exposure to the tech sector has been a hindrance.

Investors chasing growth have eschewed the UK’s premier index, since its constituents are seen as being past the growth phase. While rather more dependable, cash generative and stable, many of its companies are seen to represent the “old economy” with potential for little more than pedestrian growth.

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This can have its advantages, however. 2022 was a tough year for markets, and the likes of the S&P500 and Nasdaq fell by 19.5% and 33.1% respectively. Given its defensive qualities, however, the FTSE 100 eked out a gain of 0.9% for the year, outperforming many of its global peers by a considerable margin. By the same token, last year was a rather different time as investors sought growth once more. The S&P500 added 24.2% and the Nasdaq 43.4%, while the FTSE 100 managed a gain of just 3.8%.

In terms of valuation, the index is cheap by historic standards to itself, let alone its global peers. Whereas the FTSE 100 trades on around 10 times forecast earnings, the world index is valued at around 19 times and the S&P500 at around 21 times.

FTSE 100 at an inflection point

For many, the index is at something of an inflection point. Undoubtedly cheap, but without the propulsion of technology shares. Well regarded, regulated and respected, yet unable to attract new companies which are more highly valued among larger pools of capital elsewhere. There are rumours that the market may undergo some regulatory reform which could improve new listing prospects, but as yet without any firm details.

As it currently stands, the index runs the risk of mature companies – admittedly providing stable returns – holding back the index given the lack of true growth potential.

The index has changed significantly since 1984 (the list of original constituents at the bottom of this article demonstrates by how much), and it will likely look very different in another 40 years’ time. But it will need a seismic shift to protect its long-term future.

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The global economy continues to evolve through technology generally, and perhaps AI in particular. There are also positive implications for companies which can contribute to combatting climate change, sustainable products and changing consumer trends. So the challenges for UK firms must be faced head on. Part of this change is arguably already in train, with an estimated 75% of earnings coming from overseas, thus reflecting and benefiting from global progress.

In terms of the sectors in which the top UK companies actually operate, however, it may be that the very constituents of the premier index evolve to reflect a new, dynamic and ever-changing global environment.