Like most investors around the world, UK investors tend to have a home country bias: they have a strong preference for investing in UK stocks. This might be because they feel more comfortable investing in companies they are familiar with, or because they perceive domestic holdings to be less risky than foreign investments, in that they are not exposed to exchange rate fluctuations.
Others argue that many large UK companies are multinationals – 70% of revenues for FTSE 100 (UKX) companies come from outside the UK – and that by investing in them, they also gain indirect exposure to foreign markets.
Whatever the reason, it’s important for investors to be aware of their behavioural bias towards UK investments and to avoid concentrating their portfolios there too much.
For those seeking passive exposure to UK equities, we highlight three competitively priced exchange traded funds (ETFs) that provide exposure to different segments of the market,to suit a range of investors.
For investors seeking passive exposure to the large-cap segment of the UK market alone, the dividend-distributing iShares Core FTSE 100 ETF (ISF) is hard to fault. It charges an ultracompetitive fee of 0.07% and exhibits some of the tightest spreads on the London Stock Exchange.
However, investors should think twice about using this fund as the sole holding for their whole UK equity allocation.
The FTSE 100 may be a widely followed bench mark, often cited as a proxy for the UK stockmarket, but it is not fully representative of the entire UK market. The index is concentrated in giant and large-cap companies, so heavy investment in this ETF leaves investors underexposed to other market segments.
As a result of this focus, the fund has lagged the average active and passive fund in the UK large-cap category over the past three -, five – and 10-year periods on an annualised risk adjusted basis. The FTSE 100 has suffered from its concentration in energy and mining companies.
On the flip side, it has held up better in times of uncertainty-such as the 2007/08 financial crisis, the 2011 euro debt crisis and the aftermath of the Brexit referendum-when investors tend to flee to the safety of blue-chips.
For those looking to complement a UK large-cap allocation with a passive mid-cap investment, the Vanguard FTSE 250 ETF (VMID) is a good option. Its 0.1% charge is one of the lowest among UK mid-cap trackers, and it has tracked its benchmark closely. This is testament to Vanguard’s commitment to indexing and to its mutual structure: Vanguard is run for investors, with profits often passed on as lower fees.
However, in the context of its Morningstar investment category, investors should be aware that, being weighted in line with the market capitalisation of the companies it holds, the FTSE 250 index (MCX) (and trackers following it) will always have a natural bias towards larger companies and be underexposed to small caps relative to the average active fund in the category.
They should also note that investment trusts – a mixed bag of strategies and geographic exposures with little or no connection to the UK stockmarket- make up almost 15% of the FTSE 250. This relatively high exposure to investment trusts can hinder performance.
By aggregating the FTSE 100, FTSE 250 and FTSE Small Cap (SMX) indices, the FTSE All-Share (ASX) provides comprehensive exposure to UK stocks. Performance-wise, since its inception in 2012, the SPDR FTSE UK All-Share ETF (FTAL) has had a low tracking error, and it hasbeaten the average peer in its category, which includes both active and passive funds, on a risk-adjusted basis.
Because of its large-cap bias relative to its active peers, don’t expect the fund to be top of the pack over short periods. Active UK equity fund managers have shown they can add value by veering away from their large-cap mandates and tapping into mid and small caps when the market environment is favourable for the latter.
However, this ETF’s low cost should count over the long term. Its ongoing charge of just 0.2 % makes it the cheapest FTSE All-Share ETF on offer.
Hortense Bioy is director of passive fund research at Morningstar.
This article was originally published in our sister magazine Money Observer. Click here to subscribe.
This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise.The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.