Our new Q&A tool gives Fools the opportunity to ask each other burning questions about money. Find out what’s my favourite question this week.
If you’ve got a burning financial question, or you have a bit of expertise you’d like to share with other Fools, our new Q&A forum is the place for you. Q&A is the perfect way for the Foolish community to help each other out with those tricky financial teasers. If you haven’t seen it yet, check it out here.
Each week we’re going to pick our favourite question which we think is worth a closer look. You never know, next week we might choose yours!
Thanks go to Smiley61 for this week’s question:
Are UK index trackers the future for spreading investment risk?
Smiley61 tells us...
“I've always been an investor who has tried to reduce my risk and I'm currently investing a modest amount each month into a FTSE ALL Share Index tracker for my young daughter's future.
I've become increasingly concerned that the index is now a million miles away from UK plc, and up until recently was biased towards banks, oil companies and overseas mining companies. None of these have been star performers lately.
I'm beginning to favour more generalist investment trusts with low TERS (<1%). There are some good managers out there (Neil Woodford at Edinburgh Investment Trust).
What do you think?”
Well, I think that’s a really interesting question. We’re pretty keen on index trackers here at Fool HQ. (If index-tracking is a new one on you, read this article.) There are lots of reasons why we like trackers, but this is the biggy:
Index-tracking funds aim to match the performance of the share index they track. But because there’s no actual stock picking involved -- the fund will simply invest in any company which is quoted on the index -- there’s no need to pay high charges for a fund manager.
Many investors still choose actively managed funds in the hope that the expertise of the fund manager will lead to sparkling returns. But despite paying higher charges for this ‘expert’ knowledge, many managed funds don’t actually perform as well as the index or index-tracking funds.
So what you could be getting with a tracker is a cheaper fund which often generates a better return than many more expensive managed funds.
Are trackers too concentrated?
But Smiley61’s concern is that the stocks held in trackers have become too concentrated in certain sectors such as banks and oil companies. I think that’s a legitimate concern. The top ten companies on the FTSE 100 now make up more than 50% of the index with big hitters like Shell, BP and HSBC at the top. So there’s an argument that trackers aren’t as diversified as investors might hope.
That said, huge companies are usually well-funded and offer global diversification through their international businesses. The UK economy is faltering, so a degree of investment exposure in other parts of the world is a probably a good idea right now.
Answering Smiley61’s question, Fool Q&A poster MikeGG1 says:
“To some extent the recent collapse of the banking sector has helped to balance up the equation. By going for an All Share tracker, you are getting much closer to UK Plc than you would with the FTSE 100 because the smaller companies aren’t in the group of companies [such as banks, oil and mining companies] that you wish to exclude.”
(Read his full response and others here.)
An investment in the FTSE All Share Index covers around 99% of the UK stock market and invests in stocks quoted on the FTSE 100, FTSE 250 and FTSE Small Cap indices. In this way it blends large, mid and small cap companies making it more diversified than a FTSE 100 tracker. I think Smiley61 probably has the right idea choosing an All Share tracker over the FTSE 100.
Are investment trusts the way to go?
Smiley61 is worried the FTSE All share will continue to fall and asks whether investment trusts may be a better alternative.
In simple terms, investment trusts are companies which issue shares just like any other stock market listed company. But where ordinary companies use investors’ money to invest in their businesses, investment trusts use your money to invest in the shares of other companies.
Let’s say you want to buy shares in a property investment trust. Your money -- along with lots of other investors’ cash -- will be used by the investment trust to buy shares in a portfolio of property companies.
Unlike tracker funds, investment trusts are run by a fund manager who decides which stocks to buy and sell. So investment trusts have the opportunity to perform better than the index if the manager picks the right stocks. But that’s a big ‘if’. And even though they are actively managed some trusts charge pretty low fees too.
Four favourite investment trusts
Take a look at Fool Editor, Ed Bowsher's four favourite investment trusts here. Ed is pretty keen on Edinburgh Investment Trust which Smiley61 mentions. The trust is run by newly-appointed and very well respected fund manager, Neil Woodford at Invesco Perpetual.
I think there’s a lot to be said for picking a manager with a proven track record. But they do tend to move around, so pay extra attention if a new manager takes over your trust.
The trust invests in UK companies and aims to achieve a return which beats the FTSE All Share Index. Although the trust invests fairly heavily in oil and gas stocks (around 20%), financial stocks only account for 3.3% of its holdings, at the moment, which might appeal to Smiley61.
What’s more, the trust has a really competitive TER of just 0.43%. The TER stands for total expense ratio and covers all the costs to investors. Better still Edinburgh Investment Trust is cheaper than many tracker funds.
But times have been hard for UK stock market investors lately. The trust has fallen a whopping 24.4% in the last 12 months. Putting that in context, it has still beaten its target by outperforming the All Share Index, which dropped 30% over the same period. Nevertheless both returns are pretty dire.
Spread your risk
But it’s very important investors aren’t be too heavily influenced by short term performance. And remember there's no way of knowing which investments will be the star performers of the future.
My advice would be to diversify your investments as far as possible. In Smiley64’s case this could mean spreading investments across a number of trackers and investment trusts to exploit different investment styles and markets.
Look out for Question of the Week #2 next week.
Disclaimer: This article should not be seen as individual advice for Smiley61. We don't know Smiley's financial circumstances so we can't say for sure whether stock market investment is appropriate for Smiley or his daughter, let alone whether he should put money into investment trusts.
More: What’s In Your Tracker Today? |Choose an index-tracker ISA at The Fool
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