Buying a low-cost index tracker fund is a great way for beginners to start investing. Indeed, buying a tracker fund for an index such as the FTSE 100 gives you a ready-made, well-diversified portfolio at a low cost and minimal effort. What’s more, buying a tracker fund eliminates the need to spend hours researching active fund managers.
Still, one of the biggest problems with the FTSE 100 is the fact that it’s not reflective of UK economic strength. More than three-quarters of the index’s profits come from outside of the UK.
In comparison, the FTSE 250 is an index consisting of the 101st to the 350th largest companies listed on the London Stock Exchange and, as a barometer of UK economic performance, is more accurate than the FTSE 100.
Moreover, almost all of the FTSE 100’s largest constituents, the likes of HSBC, Shell, BP, BHP Billiton and Rio Tinto, are highly exposed to the global economy. Based on my figures, according to index weightings, around a fifth of the FTSE 100 is exposed to the mining, oil and banking sectors.
So, if China and other emerging markets are really about to enter a recession, the FTSE 100 will suffer.
Local index
While around 20% of the FTSE 100 is weighted towards the banking, mining and oil sectors, according to current weightings, just 2.6% of the FTSE 250 is exposed to mining and hydrocarbon production. The biggest sector weighting is investment instruments.
Overall, the FTSE 250 is more of a defensive play compared to the FTSE 100, which has a cyclical slant.
And all you need to do is study the performance of the two indexes over the past three months to see that the FTSE 250 is a more defensive play than its larger peer.
Indeed, over the past three months the FTSE 250 has fallen 7.6%, which disappointing but better than the FTSE 100. Since the beginning of June, the FTSE 100 has clocked up a double-digit decline of 12.9%. Furthermore, over the past 12 months the FTSE 250 has outperformed the UK’s leading index by an eye-catching 17.2% — that’s the kind of performance that can make or break a portfolio’s long-term returns.
Income index
Income seekers may prefer the FTSE 100, as it currently supports an average dividend yield of 3.9%. The FTSE 250’s average yield currently stands at 2.5%, which isn’t overly impressive. Nevertheless, the HSBC FTSE 250 Index tracker, widely considered to be one of the best FTSE 250 trackers out there, currently yields 2.7% and charges a management fee of 0.17% per annum.
Furthermore, during the past ten years the FTSE 250’s capital growth has more than made up for the index’s lack of income. Specifically, since 2005 the FTSE 250 has produced an annualised return of 10.2% for investors. Over the same period, the FTSE 100 has risen by 5.1% per annum.
Thanks to the magic of compounding, the FTSE 250’s outperformance of 5.1% per annum has added up over time. On a cumulative basis, the FTSE 250 has returned 184% since 2005. The FTSE 100 has only returned a dismal 63.7%.
