Connor Campbell
First introduced in January 1984, the FTSE 100 Index is often what people mean when they talk about the UK stock market.
It accounts for around 78% of the market capitalization of the entire London Stock Exchange, and makes headlines whenever it significantly rises or falls.
Here, we take a look at how the FTSE – or Footsie, as it is informally known – works, which companies make up the index, and how you can invest in it through index funds.
» MORE: What is an index?
FTSE meaning
Although it is rarely referred to as such, the FTSE part of FTSE 100 stands for Financial Times Stock Exchange.
This is because the index was originally a joint venture between the Financial Times and the London Stock Exchange. Its formation arose from the need for an index that could show continuously updated intraday changes in the UK stock market, following a shift towards electronic trading in the 1980s.
The 100 part of the FTSE 100, meanwhile, represents the index’s make-up. An index is designed to capture a certain segment of the financial market. In the case of the Footsie, that segment is the 100 largest companies, as ranked by market capitalization, on the London Stock Exchange.
» MORE: What is the stock market?
How does the FTSE 100 Index work?
There are a number of factors that determine not only which companies are in the FTSE 100, but how they affect the performance of the index itself.
Eligibility
A company would need to meet certain criteria to be considered for the FTSE 100. For example, it has to be a public limited company listed on the London Stock Exchange, and must match the index’s minimum liquidity requirements.
Most importantly, however, it would need to be among the top 100 companies on the London Stock Exchange in terms of its market capitalization. Market capitalization is calculated by multiplying a company’s share price by its number of outstanding shares.
The components of the FTSE 100 would broadly be viewed as ‘large cap’ companies.
» MORE: What is market cap?
Weighting
Once deemed eligible for the FTSE 100, a company’s weighting would need to be calibrated.
The FTSE 100 is weighted by free-float adjusted market capitalization. This is different from full market cap, as it only takes into account floating stock, i.e. those shares that are freely available to trade, and not restricted or closely held stock.
Both full market cap and free-float adjusted market cap are important to the FTSE 100. The former dictates whether a company can be a part of the index, while the latter informs its weighting once it has joined.
The greater a company’s free-float market cap, the bigger its weighting, and therefore the more influence its own price movements will have on how the FTSE performs.
Quarterly review
Since market cap isn’t static, neither is the make-up of the Footsie. The index undergoes quarterly reviews, which is a bit like promotion and relegation from the Premier League.
This happens between the FTSE 100 and FTSE 250, which is composed of the next 250 largest companies by market cap on the London Stock Exchange.
Where it gets slightly confusing is that a company’s market cap rank needs to fall below 110, not 100, for it to be demoted. Similarly, for a company to be promoted from the FTSE 250 to the FTSE 100, it needs to be ranked at 90 or above. This ‘buffer zone’ was put in place to avoid excessive turnover at the bottom end of the index every quarter.
What is the FTSE 100 share price?
Technically, the FTSE 100 doesn’t have a ‘share price’ measured in currency. Its value is expressed as a number, representing the overall performance of its components, measured in points. For example, you would say that the Footsie has risen or fallen a certain amount of points in a day.
It is also important to note that the FTSE 100’s value at any given moment in time does not represent the share price of all its constituents added up.
Instead, its index value is calculated using the following formula:
The free-float adjusted market cap of each constituent is calculated and added together. This sum is then divided by the index divisor.
Initially, the index divisor was designed to keep the Footsie at its original, arbitrarily set level of 1000. Since then, it has changed depending on the composition of the index. This is to ensure the FTSE’s current value can be compared to its historic performance.
What drives the FTSE’s daily movements is the changing share prices of its components and the weighting of those components.
The FTSE 100’s record closing high as of August 2021 was 7877.45 points, struck on 22 May 2018.
FTSE 100 constituents
While you may not have heard of every company on the FTSE 100, it contains some of the biggest names in the UK.
Oil and mining companies, for example BP and BHP Group, and pharmaceutical firms, such as AstraZeneca and GlaxoSmithKline, are usually near the top of the table in terms of market cap.
The banking sector, including Barclays, HSBC, Lloyds and NatWest, is a big part of the index, as are retailers, including the UK’s biggest supermarket chains Tesco and Sainsbury’s, and high street favourites WH Smith, Next and JD Sport.
There are also companies where you may not recognise their name, but you will certainly know their products, such as Primark owner Associated British Foods, Guinness and Smirnoff distributor Diageo, and B&Q parent group Kingfisher.
Why is the FTSE 100 important?
The FTSE 100 Index has become the primary reference point for how the UK stock market is performing. And by extension, it is used as a bellwether for the state of the UK economy.
This is because the FTSE’s large number of underlying assets means it can rise and fall off the back of a range of factors, including geopolitical events, such as Brexit or Covid-19, and wider economic data, such as GDP or inflation.
However, the FTSE 100 may not always be the best indicator of the health of the UK economy.
For example, the FTSE 100 can often fall as the value of pound sterling rises. This is because many of the companies in the FTSE 100 are internationally focused, and make their profits elsewhere. So the more it costs to convert, let’s say, one dollar into one pound, the less any dollar revenues are worth.
This arguably makes the FTSE 250, which is mainly made up of domestic companies, a more accurate reflection of the health of the wider UK economy.
From an investing perspective, meanwhile, the FTSE 100 can act as a benchmark with which to compare your own investment portfolio.
Say the annual return on the FTSE 100 is greater than that of your investments. You may want to look for areas of growth on the index and rejig the make-up of your portfolio accordingly.
» MORE: Investing guide and how to get started
How to invest in the FTSE 100
Since the FTSE 100 does not have a physical currency value of its own, you cannot invest in it directly.
If you want to invest in its overall performance, and don’t want to buy shares in all 100 components yourself, you would buy a financial product called an index fund.
This could be in the form of an index mutual fund, or an index exchange-traded fund (ETF).
A FTSE 100 index fund would attempt to replicate the index as closely as possible by either buying all, or a representative sample, of the shares that make up the Footsie in the same proportion as they are found on the index.
Both index mutual funds and index ETFs have their own advantages and disadvantages.
Index mutual funds, for example, can be bought directly from a mutual fund company without the need for a brokerage account.
Index ETFs, on the other hand, can be bought for as little as the price of one share, and can be traded between investors on a stock exchange.
» MORE: What is an index fund?
WARNING: We cannot tell you if any form of investing is right for you. Depending on your choice of investment your capital can be at risk and you may get back less than originally paid in.
Image source: Getty Images
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