More and more people have moved to investing in low-cost “passive” funds that buy shares in proportions that mirror the make-up of the stock market. But what are they actually buying?
In recent years more people have moved to “tracker” funds, that buy up all the companies that make up an index.
They are lower cost than “active” funds, where fund managers pick particular stocks that they think will beat the market, and do not invest in those stocks that they think will underperform.
However, a typical tracker fund will buy every company, and will invest the money according to how much of the index that company makes up. This means the larger the company, the more of your money will be invested in it.
So what does a FTSE 100 tracker buy?
The most common tracker that British investors buy is one mimicking the movements of FTSE 100 – the leading market of the largest UK companies.
Depending on how stocks have moved each day, your portfolio will look slightly different. However, this breakdown gives you a snapshot of what you will get at the moment.
If you invested £1,000 with a FTSE 100 tracker today, almost half of your money will go into 12 stocks: meaning the largest 12 companies account for £495 of your cash. In contrast, the remaining £505 will be spread between 88 companies.
The situation is made more extreme by the fact that oil giant Royal Dutch Shell has two different share classes that feature in the FTSE 100 – class A and B – which boosts its index presence.
If you drill down further into the index, around £260 of your pot will go into just four companies.
Of that £1,000, £91.50 will be invested in Shell, £70 in HSBC bank, £54 in British American Tobacco and £47 in oil giant BP.
Jason Hollands, of Tilney, the financial planning company, said that investors might also be surprised to learn that their money in invested in just a few sectors.
Of £1,000 invested in the index, around £140 will be invested in the oil and gas sector, the same in the personal and household goods sector, another £130 in banks and £110 in pharmaceutical companies.
“If you want exposure to exciting areas like technology, then you are going to need to look elsewhere as tech companies barely get a look in, representing less than 1pc of the FTSE 100 index,” he added.
“Exclusively investing through a FTSE 100 tracker won’t give investors a truly diversified approach and can actually result in a lot of company specific risk.”
How to beat the concentration
Mix active and passive
Investors who want to reduce how much they have invested in the FTSE 100 giants can use a mixture of cheap tracker funds and higher cost “active” funds run by fund managers.
In doing so they could invest in asset managers who focus on small and medium-sized UK companies. This will help to reduce your exposure to the giant companies that dominate the FTSE 100 and will give more diverse investments.
“Smart” trackers are a relatively new type of investment. They are similar to standard low-cost trackers, but they apply some screens to the stocks they invest in, meaning they are not just investing in the index as it stands.
Instead, they apply screens. One is to invest equally in all the companies in the FTSE 100 index. This means that rather than investing more of your money in the larger funds, it will split the money equally across all companies making up the index.
One example is db x-trackers FTSE 100 Equal Weight Ucits ETF. However, the annual costs at 0.25pc are higher than a traditional tracker.
Another example of these “smart trackers” is the PowerShares FTSE RAFI 100 Ucits ETF, which is a very complicated name for a fund that weights holdings based on a number of different factors. Among these are the level of sales a company has, the dividends it pays out, and cash flows. It will then allocate more money to the companies that score highly in these elements.
Because of the companies that are doing well in these factors at the moment, the ETF currently has more money invested in financial and energy companies – so at the moment it does not eliminate the large amounts allocated to stocks such as Shell. This will change over time though.
Smart trackers also come at a higher price – with this example costing 0.39pc, compared to around 0.07pc for a simple FTSE 100 tracker.
Another option is the Ossiam FTSE 100 Minimum Variance ETF. More complicated wording, but it tracks the stocks that rise and fall the least within the FTSE 100 index.
This means the exposure to oil and gas companies and banks is reduced because they tend to be more volatile. This option costs 0.45pc – so is even more expensive.
Trackers that are not as exposed
Another option is to invest in a broader index than the FTSE 100. This would give exposure to a wider range of companies, and would spread the money across more small and medium-sized companies – avoiding some of the giants.
An option for this is the HSBC FTSE 250 Index fund. It has a 0.17pc ongoing charges figure, so is cheaper than the smart trackers above.
However, Mr Hollands highlights that in this broader area of the market “there are very, very strong actively managed funds that have added a lot of value over the index”. He recommends Axa Framlington UK Mid Cap, a £175m fund run by Chris St John.