Guest post – Why I don’t invest in the FTSE 100
We have a guest post today for you by Sam from Money Nest, in Sam’s own words:
‘Sam Jefferies is the creator of Money Nest, a UK Personal Finance Blog Focused on 20-30yr olds in the UK.’
This subject is an interesting topic to me so it was interesting hearing his thoughts on it, many thanks to Sam for getting in touch with me! I won’t spoil it by letting on any further so please read on and be sure to comment with your own thoughts on it! Over to you, Sam…
I’m going to let you in on a secret. I’m both an investor and British, yet I actively avoid investing in the FTSE, in fact, I’ve gone as far as deliberately exiting funds (and paying the related charges) simply because they invest in the FTSE.
Whatsmore if you read the following, I’m almost sure you’ll take the same approach.
So why so anti-FTSE? well, for the following reasons…
Increase your diversification by reducing home bias
To begin with, it’s worth understanding that we have a natural tendency to want to invest in our national market indices, so if your British you tend to want to invest in the FTSE, whilst our American cousins broadly prefer the S&P 500.
Next, take into consideration you’re pension provider/investment fund provider knows and understands this (they spend A LOT on market research!) so the funds you are naturally funneled into investing in are dominated by investments in UK companies.
The same is true in other countries where US residents, for example, are funneled into investing into primarily US stocks.
Let’s look at an example of this; Scottish Widows (SW) represents one of the biggest workplace pension providers in the UK, primarily they funnel your hard earned cash into four different funds depending on your age (the older you are the less % of equities within the fund), this works great in theory as the funds are aimed at capturing worldwide economic growth and reduce risk as you approach retirement age.
A 29yr old, for example, would have his money auto invested in: ‘Pension Portfolio Two Pension Series 2’ (I know this because I happen to be a 29yr old with a workplace pension in SW! Anyway, enough about me…), let’s take a look at the holdings:
SW Pension Portfolio Two Pension Series 2 – Asset Class Breakdown (via Trustnet)
We can see investments in UK and EU totals up to a whopping 44.62% of the fund. Compare this to the MSCI World Index (market cap weighted stock market index of companies throughout the world) and you’ll find the UK represents a mere 6.64%, 85% less than in the Scottish Widows pension plan:
MSCI World Index – Country Weightings (via MSCI)
So what’s the issue with this? Well, if like me you wish to invest in equities to capture worldwide growth (not just growth in a Brexit looming country), by investing in these auto funds you are both reducing your ability to do this and possibly setting yourself up for reduced future returns…
Why is the FTSE underperforming against the S&P 500?
By living in several countries, I’ve developed an international mindset towards investing, this led me to explore the difference between the FTSE 100 and S&P 500 and to say I was a surprised would be an understatement:
As referenced by the Motley Fool, despite enduring similar economic challenges the FTSE 100 rose just 3% between 2005-2015 (pre and post financial crisis), whilst the S&P 500 boomed 54%.
Furthermore, between 1984-2015 the S&P 500 beat the FTSE 100 by 682% meaning a £1,000 investment would have grown by an additional £6,820.
So why is this? Partly this is due to the S&P 500 having a larger quantity of high growth tech stocks (such as Apple, Amazon and Google etc) which tend to have higher P/E ratios (price divided by earnings) meaning the entire index is priced higher when viewed through a P/E metric.
On the more anecdotal side, I can’t help but feel the higher S&P 500 returns are part due by a more entrepreneurial culture, take for example the hotbed of start-ups that emerge from Silicon Valley incubators such as Y Combinator which continues to attract entrepreneurs from around the world, plus they are not influenced by often heavy European rules and regulations (*cough* GDPR!).
Ok, so now we know the UK doesn’t make up much of the ‘world stock market’ (as represented by MSCI) and underperforms against the S&P 500, what if we want to invest in the FTSE 100 simply because we feel it benefits the nation as a whole since we’re putting our cash to work in homegrown companies rather than US ones?
Royal Britannia – Nationalism in the FTSE
An uncomfortable truth to many UK investors is that the FTSE isn’t terribly nationalistic, take the following statistics:
- 53.9% of the FTSE 100 is owned by overseas investors (possibly much higher when you take into account unit trust ownership)
- At least 14 companies in the FTSE 100 are based outside of the UK
- 71% of the companies based in the FTSE 100 generate their revenues from outside the UK
When you take the above into account alongside the lag behind the US, there is really only one other reason you may prioritise investing in the FTSE:
Tax benefits for investing in the FTSE
One of the unbelievable benefits we have as UK citizens is access to the ISA wrapper, this really is a benefit many of our European cousins could only dream about!
Yet even more surprising is that the investments we can wrap tax-free within this wrapper extend beyond the British borders. Want to invest in South American Commodities in a tax-free wrapper? No problem, go ahead…Japanese equities? Go for it!
This is fantastic for UK investors, yet not so much for the FTSE which gets no benefit for non-UK investments (of course lots of home bias in pension funds makes up for that). If however, this was re-regulated to allow only UK investments to be held within the wrapper, I could see a reason but for now, no tax incentive exists (to my knowledge).
So, in conclusion, I hope I have been able to share my own thoughts with you. As we have explored the UK tends to lag behind the US in performance, offers little to no nationalistic benefits and comes with no golden tax incentives. Meaning passive investors like myself may wish to explore whether they too are overweight in UK holdings.
Discussion (22) ¬
You don’t mention your own geographical asset allocations but does your comment mean you are heavy US? While Brexit concerns do weigh heavy on us there are opinions that this is relatively priced in. The differences in shiller CAPE between the US and UK are quite large and some believe indicate (I’m no expert) there to be more steam still in the UK prospects. I also try to be as globally allocated as possible but since a lot of my funds already have US exposure I’m treading lightly there in new investments. Interesting read though thanks.
Thanks Esthomizzy!
My main point was investing solely in the FTSE may not be optimal yet many many investors do just this (or just invest directly in shares within the FTSE).
I aim to capture world growth mainly taking the approach from the book ‘How To Own The World’ by Andrew Craig.
There are several ideas floating around at the moment that the FTSE might have better fundamentals compared to the S&P 500 so a ‘catch-up’ might be due at some point.
However I’m a big believer in the quote: ‘The market can stay irrational a lot longer than you can stay solvent!’ so I only really like to comment on what is happening in the market right now, which way is it trending for example?
Sam
Great to be featured! Happy to answer any questions that arise.
Sam
I wouldn’t consider the geographic weightings in the MSCI World Index (or similar) to be particularly relevant to my personal investment portfolio, and certainly not a “target” allocation. My approach is based on my roughly estimated lifetime expenditure with my currency / geographical asset allocations set accordingly. On that basis, 44% in the UK and Europe looks absolutely fine (you could think of it as home bias in investments matched by home bias in future expenditure)
Hey Jo,
So to confirm you have set your investments to match the countries you wish to spend money in? Is this correct?
What’s the benefit of doing this? Sounds like an interesting approach.
Sam
Yep, pretty much. There are some markets in the MSCI where it won’t make a jot of difference to my life what their stock market or their currency does (places I won’t visit and which don’t make anything I’ll be buying, as an extreme example). I don’t see any point in investing in those.
The Euro matters to me big time as I spend a few months each year on average in the Eurozone. So that’s direct spending in Euros, plus the Euro affects me indirectly in that a lot of stuff I buy in the UK comes from Europe so will get more expensive if Sterling loses value against the Euro.
So to get an idea of my currency exposure, I looked at international trade figures and my own lifestyle. The big ones are, unsurprisingly, Euros and US Dollars, so I have a target Sterling / Euro / US Dollar / Other currency allocation alongside the usual stocks / bonds / property etc asset allocation.
The whole point of investing, from my perspective, is to fund my future lifestyle. I’ve got more chance of that if I choose my investments to fit than if I go with a “World” index allocation.
Just my way of looking at it…..
Interesting approach Jo,
It’s surprising how many people are unaware that most commodities are priced in US Dollars e.g
Oil, wheat, copper etc so when the £ drops in value (like it did post Brexit decision), everything naturally goes up in price!
Sam
Hi Jo,
Have to say I don’t really get this approach. Surely if say emerging markets shot up 300% in a year it doesn’t matter whether you are living or spending in those countries that are part of that index, either way you have roughly quadrupled your money (currency fluctuations aside) and so would be much better off. The point of diversifying world wide is that you don’t know in advance what countries are going to go up or down, so you are putting eggs in many baskets. If you only invest in countries you are living/spending in and those happen to crash then you will be worse off than if you diversify, regardless of what currency each part of the index you have originate from.
I feel like I’m missing something here so let me know?
Cheers! 🙂
I’ve not actively avoided FTS100 and am probably invested more than you suggest. But I did go with Vanguard LifeStrategy knowing it would be provide a much broader coverage. (Yes, I’m a wimp for going LifeStrategy but it suits me fine)
I wasn’t aware the FTSE underperformed the S&P500, really interesting read – thank you.
Thanks Tuppenny,
What I like about the LifeStrategy is it lets you be lazy by automating rebalancing which many of us understand the benefits of but seldom actually do!
Sam
Life strategy has got a pretty big over indexing of the FTSE I am pretty sure last time I checked (probably worth double checking that before taking my word for it though). That’s why I moved into their (Vanguard’s) Total World ETF instead which allocates things more along the lines of the MSCI thingy that Sam talks about by the sounds of things.
Hi TFS and Sam,
Thanks for the article. I’m all for global investing (I actually did a post about this on my own blog recently – though I won’t be utterly shameless and link to it here). I am personally hugely into VWRL. I think, though, that there’s a little bit more nuance to the whole question when you really start digging.
At the most basic level, geographical diversification = good. In the name of keeping it simple, sign me up! However, there’s at least some counter-argument to be had to some of what you say:
1) Some of the post leans towards the idea that we can pick winners – in this case by suggesting that the USA is more full of winners than the UK. Possibly true, but trying to outsmart the markets on a hunch that this isn’t already all priced in smells a bit dangerous to me.
2) There are two separate issues. Not wanting to be overweight UK and the fact that the FTSE100 is actually quite global anyway. On the basis that you’re keen for global exposure, surely the fact that the FTSE100 is kinda global would make you *more* likely to invest in it, if anything.
3) Currency volatility. Investing in foreign markets comes with the additional volatility of exchange rates. I buy VWRL in GBP, but actually it’s pretty heavily influenced by the GBP-USD exchange rate as well as the underlying USD value.
4) Governance. Pure market cap approach doesn’t account for individual investors’ preferences to invest in countries which have high governance standards e.g. arguably UK.
Despite all of these, I’m still fundamentally with you on going global. Just thinking about the other side of things!
All the best,
Captain Thrifty
Hi Captain Thrifty,
Don’t worry about posting links on here in future if they are relevant, especially when it’s accompanied by such a thoughtful comment!
I didn’t get the “picking winners” takeaway from what Sam wrote but having read it again I can see where you are coming from.
Regards 2) surely it doesn’t matter how global the FTSE100 is. It’s all about weighting each part of the global economy by market cap and the S&P500 is much much larger.
Totally agreed on 3) and not really thought about 4) before so thanks for highlighting that one!
Cheers!
Here is a link to Captain Thrifty’s post if anyone was interested in it 🙂
http://captainthrifty.com/make-money/how-to-own-the-world-index-funds/
I like your post I agree with your arguments.
Mind- blown. This is a very interesting article! Now I’m just sat here wondering where exactly all of my pension funds are going to go!
Haha! Glad to be of use!
Just to confirm I’m not a financial advisor so can’t give advice so you may wish to speak to a pension advisor before making any decisions.
Sam
Are the % figures quoted in this article total return? The FTSE has historically had much higher dividends than the American indexes.
I also agree with Captain Thrifty, the way the article is worded smacks of beating the market “invest in the US because it will do better”
Hi Tom,
Agreed the wording may not be the best but at the risk of speaking on his behalf, I’m pretty sure that is not the final takeaway Sam was going for there, and it’s not the main thing that stuck out to me either.
Good point on the total return but would imagine S&P beat it comfortably including divs as well.
https://uk.investing.com/indices/ftse-100-total-return-historical-data
This suggests FTSE total return was 33% from 2005-2015
https://dqydj.com/sp-500-return-calculator/
This suggests the S&P total return was 73% for the same date range.
Closes the percentage gap by about 11% but still beaten comfortably. Again… past performance etc… But that is not a reason not to hold more FTSE compared to S&P is it, as that would also be trying to time the market.
Cheers!
Two things going for the FTSE100:
1) High dividend yield of around 4% – which is good if you want income now(compared to around 2% for the S&P500 and about 3.5% for VHYL.
2) Low fees on ETFs – ISF charges 0.07% compared with other options like 0.29% for VHYL.
It’s maybe a case of jam to day with the dividends – but I find that with structuring assets to generate income before state age retirement (58 onwards) the FTSE100 has a part to play.
Both great points! Thanks for chipping in with that GFF 🙂