In a previous posting, I explained why the case for passive funds is much stronger now that markets have become more efficient. However, I need to add a note of caution about the perils of some index funds, namely those that claim to track the FTSE 100.
My first beef is that the FTSE 100 isn’t representative of anything important – it’s just 100 large companies that happen to be listed on the London Stock Exchange, regardless of where their business is done. Since the rules were amended a few years ago to reflect the free float of shares some of the obvious anomalies have disappeared but it still includes stocks such as BHP Billiton, Xstrata and Anglo American which have little or no UK business.
The FTSE 100 is also not a good indicator of typical stockmarket performance because it is heavily concentrated in a few sectors, such as basic resources and energy. As a result the FTSE 100 has yet to recover the peak level reached in December 1999 of just over 7,000, whereas the S&P 500 is up by around 20% and the FTSE 250 has more than doubled.
I understand that these figures exclude dividends but to the man in the street the absolute level of the index is highly symbolic; it’s hard to get through a day without a news summary telling you what’s happened to the FTSE 100. That might explain the public’s lack of enthusiasm for equity investment compared with property and classic Ferraris.
When I began investing the FT30 was the main quoted index. It was an equally weighted index of stocks which had to have a significant UK business (British American Tobacco was a notable exclusion). It did have some useful aspects but it’s not at all suitable for the modern world of passive funds and derivative contracts.
I’d prefer to see the FTSE All Share used as the index of choice by the news programmes. Since the FTSE 100 represents over 80% of it, that won’t make a huge difference but at least there will then be some influence from the FTSE 250 and Small Cap indices. As a result the All Share has been hitting record highs recently. Perhaps one reason for it not being used as much is because it doesn’t have a very sexy name. It should be renamed the FTSE 600.
Another important issue is the use of FTSE 100 Tracker funds by retail banks as the investment product of choice to be marketed to their customers. Why would it ever be sensible to have all of your investments linked to the FTSE 100? Any wealth manager who was found to be suggesting that 100% of a client’s equity exposure should be in such a fund would have more than their knuckles rapped by the FCA.
The only reasons that I can see why a FTSE 100 tracker might make sense for a retail investor would be if it had very low charges and a minimal tracking error. Since this is a pretty simple index you’d expect that to be the norm but it’s not.
What’s the FCA going to do about it?