The FTSE 100 has started 2021 well. Last week, the index rose more than 6%. I think there’s a good chance it could keep rising now that sentiment towards UK shares is improving.
Having said that, I won’t be investing in a FTSE 100 tracker fund in 2021. Below, I’ll explain why. I’ll also look at where I will be investing.
FTSE 100 tracker funds: the investment case
One issue that concerns me in relation to the FTSE 100 index is that, while it contains plenty of world-class companies, it also contains many companies that are facing structural challenges at present.
The oil majors, Shell and BP, are an example. They are facing challenges due to the shift towards renewable energy. Meanwhile, the banks, such as Lloyds, HSBC, and Barclays, are all under threat from digital banks and financial technology (FinTech) businesses such as Monzo and Revolut.
With so many companies facing structural challenges, I don’t think it makes sense to own the whole index through a tracker fund.
Stocks Warren Buffett would avoid
Another concern I have over the FTSE 100 is that contains exposure to quite a few ‘low-quality’ stocks.
Low-quality stocks are those whose underlying businesses aren’t very profitable, have weak balance sheets, and have little in the way of a competitive advantage. These are the kinds of companies that most top investors such as Warren Buffett avoid because they’re generally not good long-term investments.
Like Buffett, I have no interest in owning these kinds of stocks.
FTSE 100 trackers have low technology exposure
Finally, the FTSE 100 doesn’t have much exposure to the technology sector. The index does have some niche tech plays such as Experian, Rightmove and Ocado. However, it lacks technology powerhouses such as Apple and Amazon that are having a profound impact on our lives today.
Given that we’re in the middle of a technology revolution, I want plenty of exposure to tech in my portfolio and a FTSE 100 tracker fund is not going to provide that.
How I’ll be investing in 2021
Looking at what a FTSE 100 tracker fund provides exposure to, I think there are better ways to invest. Here’s how I’m going to invest in 2021.
First, I’m going to pick out what I consider to be the best stocks in the FTSE 100 and invest in these directly. Unilever and Diageo are two good examples. These companies have delivered amazing returns for investors in the long run. And with both poised to benefit from rising wealth in emerging markets, I see no reason why they won’t outperform the index going forward.
Next, I’m going to look outside the FTSE 100 in the mid-cap and small-cap areas of the UK market for high-quality stocks. Gamma Communications and dotDigital are some good examples of stocks I’ve been buying in these areas of the market. These stocks have been amazing investments for long-term holders. Gamma, for example, has delivered nearly 10 times the return of the FTSE 100 over the last five years. I think it has the potential to keep outperforming.
Finally, I’ll add exposure to world-class stocks that are listed internationally like Apple, Microsoft and Amazon – all of which have strong long-term growth potential, in my view.
This approach has generated much higher returns than a FTSE 100 tracker fund for me in the last few years. I see no reason why it will be any different in 2021.
Edward Sheldon owns shares in Unilever, Diageo, dotDigital, Gamma Communications, Experian, Rightmove, Amazon, Apple, Microsoft, Lloyds Bank and Royal Dutch Shell. John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool’s board of directors. The Motley Fool UK owns shares of and has recommended Amazon, Apple, and Microsoft. The Motley Fool UK has recommended Barclays, dotDigital Group, Experian, HSBC Holdings, Lloyds Banking Group, and Rightmove and recommends the following options: long January 2022 $1920 calls on Amazon and short January 2022 $1940 calls on Amazon. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.