A much better UK barometer

The Indy 100 share index is designed to reflect the health of the economy. Stephen Foley explains which stocks made it, which didn't, and why

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Members of the Indy 100 range in size from a company worth £137bn to one worth barely one thousandth of that. Relative tiddlers such as the Harry Potter book group Bloomsbury Publishing, the takeaway chain Domino's Pizza and the funeral homes business Dignity sit alongside blue-chip names such as BP, Tesco, Marks & Spencer and Lloyds TSB. Every one is a major player in an important sector of the UK economy.

But the new index strips out some of the country's most significant companies. There is no Vodafone. No GlaxoSmithKline. No HSBC. No ICI either, which used to be described as the bellwether of British industry, but is now a speciality chemicals company with its operations and customers mainly overseas.

So how was the Indy 100 chosen? To create an index that broadly reflects the UK economy, the newspaper wanted to avoid companies with very significant operations abroad and wanted to pick members in proportion to their sector's contribution to the UK economy. A panel of The Independent's financial journalists, led by the business and city editor Jeremy Warner, was charged with picking from the 1,000-plus biggest companies on the full list and junior AIM market.

The panel took a breakdown of private-sector contributions to GDP in 2003 as its template and, for this reason, looked to pick more retailers and financial companies, for example, than pure technology firms. It looked at measures of company interests abroad, including the proportion of sales reported from overseas, as a way of screening out some companies. And then it got down to some serious haggling over the line-up.

Some exclusions were easy. Vodafone may be the UK's biggest mobile phone company but its 16.3 million UK subscribers are small in relation to the group total of 169.3 million. GlaxoSmithKline and AstraZeneca are excluded, since their fortunes rise and fall with the US drug market where they make most of their profit. And HSBC and Royal Bank of Scotland, two of the biggest quoted banks, are excluded because they have significant operations in Asia and America, respectively.

The exceptions and compromises that had to be made were more difficult for the panel to agree, and no one expects all our readers to agree. The UK's biggest company, the oil major BP, has most of its assets and operations abroad but is an integral part of the UK's corporate landscape and North Sea oil remains a large contributor to GDP. The Indy 100 needed more constituents from this sector than just Dana Petroleum, a long-standing North Sea producer, and Venture Productions, a relative newcomer.

EMI needed Coldplay to top the charts across the globe, not just in the UK, to meet its sales targets last year. But the panel wanted to reflect the contribution of the creative industries to the UK economy, so it went in, along with Pinewood Shepperton, the historic film studios. A similar exception was made for ARM Holdings, the microchip designer, which represents the UK's technological innovation.

Some 9 per cent of GDP is put down to "lettings of dwellings", which includes a notional contribution from the private housing market, while the public sector accounts for 21 per cent of GDP. The Indy 100 includes both quoted estate agents, Countrywide and Savills, to reflect the British obsession with house prices, and the panel put in support services companies such as Capita, Mitie and Care UK which are increasingly providing services outsourced by central and local government.

Inevitably, it remains an imperfect index. The biggest problem is that while manufacturing accounts for some 16 per cent of the UK economy, the panel failed to find the stocks to meet that quota. Manufacturers which are significant employers in the UK, such as GKN, tend to be global players whose overseas interests now dominate the group as a whole. Otherwise, as with the car makers left in the UK, they are niche players in private hands. The panel kept in BAE Systems and Rolls-Royce but had to look to smaller companies for other industrial representation. The Indy 100 also includes Workspace, a property company offering under-the-arches accommodation to light industry, as some sort of proxy.

The Indy 100 is as unashamedly subjective as the Dow, which retains an importance and an affection in the global financial community and with the wider public despite the existence of more representative measures of the US stock market. The 30 constituents of the Dow are chosen by the editors of The Wall Street Journal from the best the US has to offer, companies which are major players in their industries and shares which are widely held by the public. This newspaper's aim is to produce a measure of the UK stock market that is representative of the UK's diverse economy, in a way that the premier index, the FTSE 100 - dominated as it is by world champion companies operating in a globalised world - cannot any longer be. The panel will replace stocks which succumb to a takeover and will review the whole membership list each January, but changes will be kept to a minimum.

The FTSE 100 shows what it shows: the performance of the 100 biggest companies which have their headquarters in the UK, regardless of whether their operations here amount to more than a brass plaque on a boardroom door. What it does not measure is the performance of UK Plc.

More than half of the profits made by FTSE 100 companies are earned overseas, and the proportion is growing fast. The biggest groups are looking further afield for opportunities to reinvest their considerable profits, and the London Stock Exchange is attracting foreign companies put off by regulatory burdens elsewhere. The latest addition to the FTSE 100 is Kazakhmys, a recently privatised copper miner in the former Soviet republic of Kazakhstan which sells most of its wares over the border to China. David Cumming, head of UK equities at Standard Life Investments, said some important domestic sectors are under-represented. "The increase in the weighting of the oil giant Shell has dramatically increased the earnings made overseas, and mining stocks are now a much bigger part of the index. The industrial component of the index is pretty small, and investors can buy the entire quoted UK technology sector twice over for the same total value as Tesco."

The Indy 100 will be different from existing indices in ways other than just its membership. The FTSE 100 gives more weight to the biggest companies, putting it significantly in hoc to the share price of Vodafone during the late 1990s bubble (or to BP and Shell leading into the current period of high oil prices). Each Indy 100 stock makes an equal contribution to the index value, which will be calculated daily and printed in The Independent. The Indy 100, had it been in existence since 1997, would have been less volatile than the FTSE 100.

As the graphs opposite show, it could also have been a much better investment. The UK economy surfed the global slowdown after the tech bubble without sinking into recession, in contrast to many other countries, yet the UK stock market, as measured by the FTSE 100, underperformed even the US during that period. The conclusions can only be tentative (the Indy 100 notionally began with a value of 1,000 but it included only 71 members of today's index, with the other 29 added only as they floated) but what is clear is that this UK-focused index is at record levels and has outperformed significantly. These are characteristics it shares with the FTSE 250 index of mid-cap stocks.

Paul Niven, head of asset allocation at F&C Asset Management, said: "The UK economy has been driven by mortgage equity withdrawal and higher public spending on both government projects and higher wages. Those catalysts have gone for 2006. We think the FTSE 100 might outperform this year, as its investors find themselves fortunate not to be buying pure exposure to the UK economy."

Five companies that give a flavour of the index

Bloomsbury Publishing

One of the smallest companies in the Indy 100, Bloomsbury is the publishing house behind the Harry Potter books, one of the UK's most high-profile export phenomena. The company's other authors now include the quintessentially English Joanna Trollope and its successes include turning the hit Schott's Miscellany into an annual almanac.

Carphone Warehouse

The retailer-turned-telecoms company is in the Indy 100 despite significant operations across Europe. It is a British entrepreneurial creation and is also a proxy for the important mobile phone industry. The mobile operator Vodafone has been excluded and O2 and Virgin Mobile are being taken over.

BP

The UK's biggest company, the oil major BP, drills and sells, in the main, abroad. But it is an integral part of the UK's corporate landscape, a significant employer and training house for oil industry professions. And although North Sea oil production is in decline, it remains a vital part of the UK economy, as the Chancellor's recent grab at "windfall profits" proves.

Man Group

One of the exceptions to our general rules, the hedge fund manager Man Group - run by Stanley Fink, right - is in the Indy 100 despite managing more money for overseas clients than it does in the UK. It is in to reflect the strength and adaptability of the City of London as an innovative financial sector, second only to New York in the brave new world of hedge fund investment.

Tesco

J Sainsbury and other smaller grocers do not have a significant presence abroad and would more than satisfy the supermarket industry quota for the Indy 100, and the panel was attracted to the apparent perversity of excluding a company which accounts for £1 in every £8 spent by UK consumers. In the end, Tesco's position (under Sir Terry Leahy) as the UK's biggest online retailer - a sector that will become ever more important - tipped the balance in its favour.

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