Is the FTSE 100 still fulfilling its purpose and worth investing in at 40?

Wednesday 3 January 2024 is the 40th anniversary of the FTSE 100 index.

Over its history, London’s blue-chip benchmark has delivered a solid return, but has underperformed overseas rivals in the 2010s and 2020s.

This has called into question whether the FTSE has fulfilled its purpose – as well as what that purpose is or should be – as well as whether it continues to be useful for investors now and into the future.

Since being launched as the 'Stock Exchange 100' at the start of 1984, then quickly becoming the FT-SE and then FTSE 100, the index constituents have been chopped and changed copiously in the intervening years – with only a quarter to just over a third of the original companies remaining, depending on how you cut it.

Looking back at how the index has changed over the years seems to provide some insight into how index has performed and why it has struggled in recent years, with the 2023 gain for the ‘Footsie’ extremely underwhelming compared to most other stock markets.

How the FTSE 100 has performed in its 40 years

First, let’s review the performance of the index over the past four decades and compare that with some other international benchmarks.

Index Since Jan 1984 1984-1990 1990s 2000s 2010s 2020s Since 2000

FTSE 100 5.2 11.1 -1.5 1.6 0.5 0.4

MSCI Europe ex UK       7.8 22.5 11.9 0.3 4.7 5.2 2.9

MSCI World       7.7 18.6 9.6 -0.7 9.5 8.8 4.4

S&P 500             9.1 11.6 15.3 -1.1 13.4 11.5 6.1

TOPIX   4.6 33.7 -1.7 -3.5 7.1 1.9 0.9

Source: Morningstar, and AJ Bell, price return in GBP to 26 December 2023

When the FTSE 100 passed the 8000 mark for the first time last February, it provided hope that UK stocks were being looked at with renewed enthusiasm – even if many felt it did not entirely make sense.

While the Footsie has for some years been seen as undervalued in comparison with overseas rivals, full of companies that are relatively cheap versus global equities, it can also be pulled hither and thither by its heavy weighting to mining and commodities giants.

Since the turn of the millennium the apparent malaise infecting the UK stock market is “somewhat of a mirage”, says Laith Khalaf, head of investment analysis at AJ Bell, as index comparisons are undermined by the weakness of sterling and the fact dividends are not included in the headline FTSE 100 index.

As such, the Footsie may be a good barometer of the day-to-day movements of UK stocks, but is “a wholly inadequate measure of the long-term returns accrued by investors”, he says.

Taking dividends into account means the FTSE’s return since 1986 is 8.6%, compared to 8.7% for continental Europe and 9.1% for the MSCI World, and a bit closer to the 11.4% for the S&P 500.

Adding in dividends and currency effects provides a stronger account of the FTSE 100.

As says Richard Hunter, head of markets at Interactive Investor: “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 on the FTSE100 is around 12%, he says, but with dividends reinvested, the total return leaps to 163%.

The power of compounding is even more compelling over greater periods of time, with Hunter noting that going back to 1984 a £1,000 investment would now be worth £7,700 on a simple return basis, but over £22500 in total returns.

Annualised total return (dividends reinvested) in local currency %

              Since January 1986       1980s* 1990s   2000s   2010s   2020s              Since Jan 2000

FTSE 100            8.6        19.7      15.7      1.9        5.5        4.2        4.1

MSCI Europe Ex UK       7.4        12.5      15.7      -0.9       6.6        6.1        3.9

MSCI World       8.1        19.4      11.0      -0.3       10.5      9.9        5.6

S&P 500             11.0      17.7      18.2      0.4        14.0      12.1      7.1

TOPIX                 N/A       N/A       -4.2       -4.5       8.8        10.6      3.1

The best FTSE 100 performers

The biggest gainers on FTSE 100 will perhaps surprise.  

First listed as Reed International when the FTSE was launched, but now called RELX PLC (LSE:REL), the recruiter turned publisher has produced the largest share of market returns over the last four decades.

This is closely followed by British American Tobacco and Rio Tinto, according to research by Hargreaves Lansdown.

Looking at the past year, 15 of the 26 original constituents which were in the FTSE 100 back on 3 January 1984 have risen.

The biggest gainer in the past 12 months was Marks and Spencer Group PLC (LSE:MKS), up 115%. 

Over the past two decades four names, JD Sports, Ashstead, London Stock Exchange Group and Diploma have regularly popped up as being among the biggest risers over key time periods, says HL's Susannah Streeter. 

"All four companies were in the top ten performing stocks, over the last twenty years, over the last ten years and over the last five years, and all ended 2023 having gained double digits."

While tech stocks hold huge weight on the Nasdaq and S&P 500 most US tech focused firms don’t pay dividends, she adds, unlike many of the constituents of the FTSE 100.

"Listed multinationals have global sources of revenue and are highly cash generating, so are more reliable income players."

Why has the FTSE 100 index underperformed?

Though some individual companies have been extremely rewarding for investors, on an annualised basis, as seen in the table above, the London index is still among the backmarkers in the 2010s and 2020s.

The angst around the FTSE and UK stocks, along with their eclipse by the S&P 500 and Nasdaq has not coincidentally overlapped with a period when domestic UK investors have been selling out of UK equity funds, culminating in a £50 billion outflow in 2022 and £37 billion withdrawn in the first 10 months of 2023.

The FTSE’s low exposure to tech stocks is widely seen as holding it back against many indices, New York’s S&P 500 and Nasdaq in particular.

It has a very strong bias to the Old Economy, notes Jason Hollands, managing director at BestInvest, in particular to three sectors: energy (11.6% with Shell at over 9% weighting), healthcare (11.2% with AstraZeneca and GSK near the top) and financials (10.9%), with a shortage not just of technology stocks (1.3%) but ‘growth’ sectors generally.

“The reason the FTSE 100’s performance has lagged similar stock indices in the US is the same as why value stocks have underperformed so-called growth stocks in those US indices,” says James Proudlock, managing director of OptionsDesk.

To illustrate this point, he points out that the S&P was up 24% in 2023 but just seven of the 500 component stocks contributed about two thirds of the index’s gains.

“America has been far more successful than the UK in attracting technology company listings, and as the world moves towards a fully digital future this is where the growth has been. By contrast the largest FTSE weightings by sector are consumer staples, financials, energy and mining.”

Joachim Klement, strategist at Liberum, says the weakness in performance over the last couple of years has to do with two factors.

“First, the large exposure of the FTSE 100 to commodity sectors which have gone through a long bear market since 2011 and the large exposure to banks with have struggled since the financial crisis in 2008.”

“Because the FTSE 100 is much more exposed to these sectors than, say, the rest of Europe or the US and underexposed to booming sectors like technology and communication services, the FTSE 100 could not keep up with the rest of the world.”

Another technical factor has also hit the London benchmark, say Klement and Neil Wilson, chief market analyst at Finalto, who both point to the massive reduction by funds of holdings of UK stocks.

In the last 20 years, holdings of UK listed firms by UK pension and insurance funds have plummeted from around 50% of their portfolios to about 4%, Wilson notes.

(In a large part this relates to the dotcom bear market of the early 2000s when fund deficits rose, liabilities rose, bond yields fell and, says Wilson, “UK funds switched from equities to gilts and never stopped”. But that’s worth another whole story.)

UK stocks now make up just 4% of the global developed stock market, down from 10% a little over a decade ago and less than the amount made up by Apple or Microsoft individually.

Khalaf says this is “a small enough fraction of the MSCI World Index that global fund managers could happily turn a blind eye towards the UK without taking too much risk against their benchmark”.

Does the FTSE 100 still fulfil its purpose?

As a representative benchmark for the largest stocks in the UK and the UK stock market overall, most in the City seem to agree the FTSE 100 has fulfilled its purpose and continues to do so.

Many people outside the Square Mile (and some inside it), however, think of the FTSE 100 as an economic bellwether for the UK.

This misses its purpose, says Proudlock. “When the FTSE 100 index was first launched in 1984, the City of London was preparing for a massive deregulation driven by then prime minister Margaret Thatcher to make the UK stock market an attractive venue for global corporations to list their shares.”

The primary purpose of providing a “highly liquid, tradeable benchmark no matter how extreme the trading conditions and market environment” remains, says Proudlock.

Most of the companies in the index are international in focus, with the UK one of many locations or markets, and the performance of the index is calculated by the weighting of each component by its market capitalisation.

This weighting leads to the performance of its largest companies having the biggest effect on the index’s performance, Proudlock points out.

“So when you’re trading the FTSE, it’s important to understand how the performance of its top companies like Shell, Astra Zeneca, HSBC, Unilever, BP and Rio Tinto affect the performance of the index as a whole.”

The composition of the index, adds Wilson, “is reflective of what companies we do well and which sectors we have lost – tech has been a big black hole and that is reflected by the index…it’s not the fault of the index that the [London] equity market is not what it used to be either”.

As such it fulfils its purpose as a “pretty good gauge” of the stock market, he says, broader than some peers but less broad than others.

Klement suggests the FTSE 100 is a decent benchmark for foreign investors, who often own UK stocks as part of a European or global stock portfolio so are not going into as much granular detail.

But, if your definition of UK benchmark is the performance of the UK economy, Proudlock and Klement suggest that perhaps the FTSE 250, or FTSE 350 which combines both indices, or FTSE All-Share are more representative benchmarks for UK Plc and the development of UK businesses.

“The shortcoming of the FTSE 100 as a benchmark is that it does not reflect the UK economy or UK Plc overall very well,” says Klement.

“This is because the index is dominated by commodity companies (energy and mining) and by foreign earners.”

Only 18% of the revenue generated by FTSE 100 companies comes from the UK, while 82% of revenues come from abroad.

For the FTSE 250, 52% of revenues are generated at home and for the FTSE Small Cap, it is around 70%.

Is the FTSE 100 worth investing in?

Khalaf: “The UK does look undervalued compared to the US market, but that has been the case for most of the last 40 years. Contrarian investors might still be tempted to buy UK stocks, though they would need to exercise some patience as a renaissance may not materialise any time soon, given long-standing trends in investment flows which show no sign of abating. The good news is that with a forecast yield of 4.2% for 2024, investors in UK plc are at least being paid to wait for a turnaround in fortunes.”

Hunter: “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 overall as investment destination has failed to recover. In terms of valuation, the index is cheap by historic standards to itself, let alone its global peers. Whereas the FTSE100 trades on around 10 times earnings, the world index is valued at around 19 times and the S&P500, for example, at around 21 times. For many, the FTSE index is at something of an inflection point – undoubtedly cheap, but without the propulsion of technology shares. 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 will look rather different in another 40 years’ time, but in the interim it will need a seismic shift to protect its long-term future.”

Proudlock: “As with value versus growth, the FTSE 100 will likely perform strongest when inflation is back under control, real interest rates low, and consumers start spending. Also, as with the TMT (Technology, Media and Telecom) boom and bust of the late 1990s, the FTSE will perform best when the real economy reasserts itself and valuations rise as investors refocus on neglected segments of the economy.”

Hollands: “What the FTSE does undeniably have in its favour are strong income characteristics. It has long been the highest yielding developed market index and continues to be so with a dividend yield of circa 4%. The FTSE currently looks incredibly cheap, so there are certainly opportunities for bargain hunters. Basically, the FTSE 100 is worth buying if you are bullish on energy and commodities and for income seekers.”

How to invest in the FTSE 100

The most straightforward way to invest in the FTSE 100 is to buy an exchange-traded fund tracking the index.

FTSE 100 trackers include the iShares Core FTSE 100 ETF, HSBC FTSE 100 Index fund, Lyxor FTSE 100 UCITS ETF and FTSE 100 Index unit trust.

These are passive funds that seek to track the performance of the FTSE 100 Index.

For investors wanting to use passive funds to get a broader exposure to the UK, Khalaf notes that picking out less well recognised companies down the UK scale has been a winning strategy over the long term, with the FTSE 250 index of midcap UK companies returning an annualised 7.7% compared to 4.1% from the FTSE 100, both with dividends reinvested.

As with the FTSE 100 trackers, there are iShares, HSBC, Vanguard and other FTSE 250 trackers available on every investment platform.