It’s well-known that many active investors fail to beat their benchmarks, like the FTSE 100 year after year. This trend has led many investors to buy low-cost FTSE 100 index trackers as an alternative to actively managed funds.
Nevertheless, I believe that many UK investors are making a mistake by investing in the FTSE 100. You see, the FTSE 100 is an international index — it’s estimated that 70% of the FTSE 100’s profits come from outside the UK.
So, when you buy the FTSE 100 as a whole, you’re placing a bet on international growth. What’ more, the FTSE 100’s top nine constituents account for nearly 40% of the index.
With this being the case, the FTSE 100 index is hardly the best index to track. Indeed, for a play on UK economic growth the FTSE 250 is a better bet. And to profit from global economic growth, it could be better to track the S&P 500, STOXX 600 and MSCI World indexes.
Diversification wins
At its core, the FTSE 100 is an index made up of a few main holdings, including HSBC, Royal Dutch Shell, Vodafone, BP, British American Tobacco, and GlaxoSmithKline. Such a concentrated portfolio may suit some investors, but it’s hardly a recipe for growth.
For example, the FTSE 100 has returned 400% over the past three decades, a compound annual growth rate of around 5.6% per annum excluding dividends. However, over the same period the S&P 500 has returned 1080%, excluding dividends, a compound annual growth rate of 8.8% per annum.
Similarly, during the past five years the STOXX 600 and MSCI World indexes have both outperformed the FTSE 100 by 22% and 64% respectively.
It’s pretty easy to see why these international indexes have been able to beat the FTSE 100 over the years. The FTSE 100 lacks diversification and as a result, the index is falling behind.
As their names suggest, the S&P 500 and STOXX 600 have 500 and 600 constituents respectively. The constituents are the largest companies in the world with household names such as Coca-Cola, Johnson & Johnson, Nestle, Apple and Google featuring in the top ten holdings.
Further, as the STOXX 600 is designed to represent the 600 largest European companies, many of the index’s top constituents are also included in the FTSE 100. HSBC, Shell and BP are just three of the STOXX 600’s top 10 components.
If you’re looking for even more diversification, the MSCI World index tracks the share price of more than 1,660 companies. The index has risen by around 7.1% per annum since 1994.
Three top trackers
Replicating the performance of the STOXX 600, S&P 500 and MSCI World is just as easy as replicating the performance of the FTSE 100 — all you need to do is buy a low-cost tracker.
There are plenty of low-cost trackers out there, but three of the best are the iShares STOXX Europe 600 UCITS ETF, which has a total expense ratio of 0.20%. The $160bn SPDR S&P 500 ETF Trust, which has a total expense ratio of 0.09%, and the MSCI World ETF, which has a total expense ratio of 0.24%.
