I recently came across one of the most interesting observations on equity markets that I’ve read in years, courtesy of my former Financial Times colleague David Stevenson. David did a simple but revealing exercise to illustrate the dangers (or otherwise) of making poorly timed investments.
He identified 16 distinct peaks between 1987 and 2020 in the main US equity index, the S&P 500, that were followed by sharp drops, along with 12 in the UK’s FTSE 100. He then looked at the fate that awaited investors who bought those indices at their peaks – the worst moment possible. The results tell a fascinating tale.
Anyone who invested in an S&P 500 tracker at one of those 16 peaks would have been horrified at what happened next. But if, instead of selling in a panic, they held their investment for 10 years, they would have made money 13 times out of 16 – “in most cases a very substantial gain”, writes David. What about the FTSE 100 investor? If you had piled into a tracker at any of this index’s 12 peaks, patience and a long-term outlook would have served you less well. In 8 out of 12 cases your investment would have still been underwater a decade later.
UK versus USThe comparison is shocking. But looking at the FTSE All-World index since 2003 (when FTSE changed the rules governing its composition), and shortening the holding period after market peaks from ten years to five, confirms the pattern. In this case, badly timed investments at interim highs produced gains 5 years later, 14 times out of a possible 17. It’s tempting to conclude that the gap in performance between the US and UK indices simply reflects the two countries’ diverging economic fortunes. The US has remained the world’s most dynamic developed economy over the past 33 years, while the UK has continued its slow relative decline. Perhaps that explains why even patient investors in the FTSE 100 are so poorly rewarded.
It’s a tempting conclusion, but a wrong one. The UK’s flagship equity index has comparatively little exposure to the British economy – the companies it contains generate some 70% of their revenues outside the UK. By comparison, the 500 constituents of the flagship US index generate around 30% of their aggregate revenues outside the US, according to a report by S&P Global, citing research by Goldman Sachs.
The UK’s best-known index is loaded to the gunwales with cyclical, low-growth sectors
In part, this is what we should expect to find if we compare a big country with a small one. The US has a far larger economy than the UK. Its gross domestic product was US$20.8tn in 2019, according to the International Monetary Fund, versus Britain’s US$2.6tn. US companies, therefore, have a much larger domestic market to go after. It is hardly surprising that it should account for 70% of their turnover, on average.
So, the relatively poor long-term performance of the UK’s FTSE 100 versus other major indices is not explained by its exposure to the UK economy. In fact, the companies in the FTSE 100 have unusually high exposure to economies other than the UK, many of which are growing faster.
Why, then, has its performance been so disappointing?
A lesson for UK investorsThe answer boils down to the mix of sectors. The FTSE 100 is heavily weighted towards sectors that are either extremely cyclical or have relatively unattractive long-term growth potential, or both. According to data published by Siblis Research, sectors such as mining and materials have hovered between 2% and 3% of the S&P 500 over the past five years, but have climbed from 5% to 12% of the FTSE 100 over that period. Energy has declined in both indices, but remains around 10% of the FTSE 100 against just 2% of the S&P. Consumer staples have been between 16% and 18% of the FTSE 100, but have dropped from 10% to 7% of the S&P, while financials have dropped from around 16.5% to 9.7% of the S&P 500, but have fallen much more slowly in the FTSE 100, from 23.4% to 17.7%.
Technology, the key growth sector since the internet bubble of 2000, has climbed from 20.7% of the S&P to more than 28% over the past five years. In the FTSE 100 this sector is flat over the past five years, reaching 1.4% of the index in mid-2020. Only in healthcare is the UK index comparable with the US.
The lessons for UK investors are stark. If, like many, you are governed by home bias, and you believe that low-cost trackers deliver better results, you might well be persuaded to buy a FTSE 100 tracker. You might even comfort yourself that doing so gives you broad international exposure – remember that 70% of its revenues are non-UK.
But if you fall into this camp, you are taking far more risk than you are probably assuming. A FTSE 100 tracker is not a low-risk investment. The UK’s best-known index is loaded to the gunwales with cyclical, low-growth sectors and is badly deficient in those that will power the economies of the future. No wonder the penalties for mistiming your investments in this index turn out to be so heavy – and no wonder so many British savers regard investing in the stock market as far too risky for them.
This article was originally published in the February 2021 flipbook edition of The Review.
The full flipbook edition is now available online for all members.