Most people’s impression of stock market investing is influenced by the level of the FTSE 100; it’s the number that gets quoted everyday by the media. Hovering just over 6,000 now, compared with a peak around 7,000 over 15 years ago, it doesn’t appear to have been a successful investment, so you can understand why the general public views equities as a pretty dull opportunity. UK residential property has increased by more than 160% over that period (source: Nationwide) with much less volatility on the way.
Fortunately, that FTSE 100 figure does not give an entirely accurate picture of what has been going on. First, it excludes the impact of dividend income, which over the long term typically accounts for the largest part of total returns. Even if you had invested in the very expensive Virgin FTSE 100 Index fund 15 years ago (and many people did – it was one of the most popular funds then) you would have achieved a total gain of 62%. Nothing to shout about but slightly better than cash on deposit.
However, if you’d invested more widely the results would have been significantly better. For example, over the same 15 years when the FTSE 100 has gone backwards, the FTSE 250 (which represents the next 250 large companies) has risen 170% (not including dividends)! Now there is some longstanding evidence that smaller companies produce better returns than their larger cousins but this disparity seems pretty extraordinary.
One reason is that the FTSE 100 is simply not a well-balanced index. It is compiled of (broadly) the 100 largest companies quoted on the London Stock Exchange. Some of these have negligible operations in the UK (e.g. Anglo American Mining, Antofagasta, Carnival, Glencore), others did set out as UK companies but now derive most of their income from overseas (e.g. Vodafone, BP, Shell). Perhaps more importantly the FTSE 100 has negligible exposure to technology, which represents about 20% of the S&P 500, the major US equity index.
..the FTSE 100 is simply not a well-balanced index
We believe that successful investment requires a well-diversified portfolio. That means investing globally and across multiple asset classes. Over the last 15 years this has proved to be a successful strategy: the MSCI World Index which is a measure of global stock markets has produced a total return of 71%. The FTSE Wealth Manager Balanced Index (which includes weightings to other assets such as fixed interest bonds and property) and is more representative of a typical private client portfolio has returned over 92%.
It is clear that the FTSE 100 is an anomaly that is not very representative of what is happening to most people’s investments. Properly diversified portfolios have delivered respectable returns. Not as good as residential property but with the value of the latter now reaching unprecedented levels relative to incomes it would be a brave call to expect a similar outcome moving forward. Especially after taking account of it being considerably less tax efficient with an extra 3% stamp duty plus no tax deductibility for interest.
But what about the next 15 years for the FTSE 100? We can be fairly sure there will be booms and busts with the names of the key protagonists changing. I firmly believe that we have entered a new investment era that will see lower returns from property, bonds and the stock market. For investors getting the basics right: thorough research, broad diversification and regular rebalancing of portfolios – will become more important than ever.
We’ll also see the rise of niche areas like impact investing experience dramatic expansion and break into the mainstream. Companies that are delivering solutions to very real social and environmental problems are operating in sectors with high growth potential. I fully expect to see a FTSE 100 titan emerge from this space.
This article first appeared in Money Observer on 12 January 2016.