Like many investors around the world, UK investors have a home-country bias; a strong preference for investing in UK stocks.
This may be because they feel more comfortable investing in businesses they are familiar with or because they perceive domestic holdings as less risky than foreign investments as they are not exposed to exchange-rate fluctuations.
Others may conclude that many large UK companies are multinationals – 70% of revenues for FTSE 100 companies come from outside the UK, so by investing in them, investors can gain indirect exposure to foreign markets.
Whatever the reason, it’s important to be aware of this behavioural bias and make sure it does not lead to an overly concentrated portfolio.
For those seeking passive exposure to UK equities, we highlight below three competitively-priced ETFs providing exposure to different segments of the market, to suit different investors.
iShares Core FTSE 100 ETF (ISF)
For investors seeking passive exposure to the pure large-cap segment of the UK market, the dividend-distributing iShares Core FTSE 100 ETF is hard to fault. It charges an ultra-competitive 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 sole holding for their whole UK equity allocation. The FTSE 100 may be a widely followed benchmark, often cited as a proxy for the UK stock market, but it is not fully representative of the whole UK market. The index is concentrated in giant and large caps and leaves investors underexposed to other segments.
As a result, 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 at times of uncertainty, such as the 2007-08 financial crisis, the 2011 Euro debt crisis, and the Brexit referendum, when investors tend to flee to the safety of blue chips.
Vanguard FTSE 250 ETF (VMID)
For those looking to complement a UK large-cap allocation with a passive mid-cap investment, the Vanguard FTSE 250 ETF is a good option. At 0.10%, it is one of the cheapest UK midcap trackers. It has also tracked its benchmark very closely. This is testament to Vanguard’s commitment to indexing and its mutual structure; Vanguard is run for investors, with profits often passed on as lower fees.
In the context of its Morningstar investment category, investors should be aware that, being a market-capitalisation-weighted index, the FTSE 250 will always have a natural bias towards larger companies and be underexposed to small caps relative to the average active peer in the category.
Additionally, the index allocates almost 15% of its weight to investment trusts--a mixed bag of strategies and geographic exposures with little or no connection to the UK stock market. This relatively high exposure to investment trusts can be a drag on performance.
SPDR FTSE UK All Share ETF (FTAL)
By aggregating the FTSE 100, FTSE 250 and FTSE Small Cap indices, the FTSE All-Share provides comprehensive exposure to UK stocks.
Performance-wise, since inception in 2012, the SPDR FTSE UK All-Share ETF has exhibited low tracking error. It has also beaten the average peer in the category, which includes active and passive funds, on a risk-adjusted basis.
Because of its large-cap bias relative to active peers, one shouldn’t expect the fund to land at the top of the pack over short time horizons. UK equity managers have demonstrated they can add value by veering away from their large-cap mandate and tapping into mid- and small-caps when the market environment is favourable to the latter.
But this ETF’s cost advantage should make a difference over the long term. With an ongoing charge of 0.20%, the fund enjoys a considerable cost advantage. It is also the cheapest FTSE All-Share ETF on offer.
A version of this article appeared in Money Observer magazine
