The price of the FTSE is measured by adding up the total market capitalisation.
September 26, 2021
What do you really know about the FTSE 100?
In the UK we are all familiar with the FTSE 100. It is the index that measures the value of the top 100 companies on the London Stock Exchange (LSE) by market capitalisation and was created on 3 January 1984 with a start value of 1000.
But what do you really know about it and its returns? The value of the top 100 companies moves all day every day. The cash market opens for trading at 8.00am, and closes at 4.30pm.
However, what you might not realise is that it is also moving almost every hour in-between. Equity derivatives, such as futures, or CFD’s are open pretty much 24 hours a day, closing only at 21.00 on Friday night, until reopening at 23.00 on Sunday night.
When the papers report that the FTSE is up 1% on the day, it might actually be lower than it was the night before. However, the world of equity derivatives is a complicated one, and perhaps a conversation for another day.
The FTSE 100 and what we do know:
The price of the FTSE is measured by adding up the total market capitalisation, or essentially the companies’ market values, of the top 100 companies in the UK.
To explain very briefly, this is reached by multiplying a company’s current share price by the number of shares in issue, before multiplying this number by the company’s ‘free-float factor’, or the numbers of shares that are available to trade on the market. This results in a value that indicates how much the company is worth according to the market.
Every quarter, the index provider, FTSE Russell, reviews the index to see if any members should be relegated, or promoted from the FTSE 250 (essentially, division 2). For a company to enter the FTSE 100 in a reshuffle, it has to have a market cap that puts it in the top 90 by size. Similarly, once in the FTSE 100, a stock has to fall quite far to be relegated: it has to have a market cap below that of the 110th biggest company in the UK stock market.
This is designed for obvious reasons and prevents the constant movement of companies up and down, if they have a good or a bad quarter. Last year, due to the pandemic, EasyJet fell out of the top 100.
It’s an efficient system, and one that we have pointed out will work well for the UK over the next decade, due to the increase in technology stocks appearing on the horizon. Tech stocks, which are sparse in the 100, are often valued by the market in terms of potential earnings ie. Growth stocks. This means that as more growth stocks enter the market, the higher the potential market valuations become in the FTSE 100 and therefore, increasing the value of the index.
This is one reason why The Portfolio Consultancy are suggesting holding more FTSE than any other index at the moment. As a long-term play, it is by far the most undervalued index in the developed world.
Average returns for the FTSE 100:
The return for the FTSE 100 is linked to the price of the index you will see as quoted by the financial news. For example, the price of the FTSE 100 ended 2019 at 7542.44, 12.1% higher than 12 months earlier.
In 2020, due to the pandemic, the FTSE ended the year at 6,460, 14.3% lower than where it began.
These were 2 very different years, and they very effectively highlight why we cannot look at short-term data for a long-term strategy.
Looking back over a longer time frame gives an investor a better idea of the average return they can expect. Between 1984 and 2019, the FTSE 100 rose by 654% in price, this amounts to an annual price return of 5.8%
FTSE performance over ten-year periods:
Over the last ten years the total return for the FTSE 100 was 103.98%, if you reinvested dividends, or 7.38% as an annualised return.
Looking at all the possible ten-year holding periods since Index’s inception, shows an average annual return of 8.43%.
Now that we have an average longer-term annual return, let’s look at the possible drawdowns seen in the same time frame so we can evaluate the risk-reward.
You would think that investing in the FTSE, the 100 largest companies in the UK, would be the safest of all equity investments. I’m sure your investment manager would tell you this too, and they aren’t wrong. However, has anyone ever discussed the drawdowns in the same period?
As you might remember from a couple of weeks ago, the drawdown is the largest fall, from peak to trough, of any investment strategy since its inception.
Largest drawdowns for the FTSE 100:
The largest ever peak-to-trough decline was 52.6% which reached its bottom in March 2003. A number of events put downward pressure on UK stocks during this bear market. The collapse of the dotcom bubble began the massive declines in the share prices of many of the top 100 companies.
More damage was done by the 9/11 terrorist attack in 2001, and it wasn’t until after the start of the Iraq War that the FTSE reached a bottom of 3287 in March 2003.
Other large drawdowns include:
- 35.9% in November 1987
- 49.3% in March 2009
- 36.6% in March 2020
Each time, the markets have come back, and if traded carefully, each of these drawdowns is an opportunity (although it may not feel like one at the time). The Portfolio Consultancy’s Global Equity Strategy last year netted a fantastic profit, but in contrast to this, most UK equity funds lost around -11% on the year because they did nothing in response to the pandemic.
As we’ve seen, buying and doing nothing over a long period of time, will produce an average return of 8.43%.
BUT, bear in mind, that during this time, inflation has averaged around 2.1%, so in real monetary terms, the return is closer to 6.33%.
As we showed last week, your IFA will have charged you on average around 1.5% per annum including all platform costs that you may or may not know about.
This leaves an actual return of around 4.83% after costs.
If the FTSE itself is the safest of UK equity investments, as it should be, then here are its stats as a strategy if it were to be displayed on The Portfolio Platform.
Annualised return: 4.83%
Max drawdown: 52.6%, or 36.6% if your investments don’t go back as far as 2003
Now that you know this, have another look at the performances on The Portfolio Platform and make up your own mind. If it looks too good to be true, it isn’t. These performances are 100% verified by an FCA regulated broker as well as our management team. Our software doesn’t lie, our performance records, do not lie.
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