Outlook: The problem with the FTSE 100

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THE ELEVATION of Compass, the contract catering group, to the FTSE100, is a better choice of constituent than another bank, but the fact remains that the index has become a curiously unrepresentative and quite dangerous yardstick of stock market behaviour and activity. Banking and other financial services already account for more than 30 per cent of the index, and with Northern Rock hovering on the brink of inclusion, that looks destined to rise even further.

Pharmaceuticals account for another 12.5 per cent of the index. What with all that consolidation, privatisation and conversion, the Top 100 have come to represent more than three-quarters of the value of the entire stock market. In itself, this is indicative of a worrying imbalance in the UK economy. One of Britain's biggest economic weaknesses is that though it has its fair share of leading world class companies, it is deficient in small to medium sized enterprise. There can be no more graphic an illustration of this failing that the FTSE 100. The size of the index and the dominance of just two sectors is also distorting investment patterns.

As a result, the time may have come for FTSE International, which runs these things, to have a bit of a rethink and look at ways of modifying the monster they have created. In spite of a recent return to form by the mid-caps, the gap between the Premier division of companies and the rest continues to widen. With so many tracker funds now in operation, promotion to the blue-chip ranks now provides a rocket boost not all the constituents deserve. Conversely, relegation is an ever more painful experience - worse even than a Premier League football club losing all that Sky TV money when they plunge into Nationwide obscurity.

The whole thing is in any case turning into a self-perpetuating spiral. Since Footsie performs better than the market as a whole, more and more investors are turning from active fund management to FTSE 100 trackers. As a consequence more and more money gets pushed into the FTSE. This is not mere intellectual conjecture. There's plenty of evidence of it. We may even be witnessing an investment bubble in the making.

FTSE International says the index was set up to represent the largest companies. The index therefore simply reflects what is going on in the real economy. Industries that are consolidating, like banks and pharmaceuticals, become more significant constituents, while others that are following the demerger trend, like conglomerates and retailers, drop out.

All the same, there is plainly cause for concern here. The boffin fund managers, brokers and actuarial consultants who make up the indices committee should put some wet towels on their heads and do some thinking.