ETF Investors: Make Sure You Buy the Right Market

By buying a FTSE 100 index fund or a FTSE 100 ETF, you’re getting exposure to only 100 stocks; you’re not “buying the whole UK market”

Emma Wall 10 June, 2016 | 11:15AM
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Emma Wall: Hello, and welcome to the Morningstar series "Ask the Expert." I'm Emma Wall and I'm joined today by Hortense Bioy, Director of Passive Funds Research for Europe.

Hello, Hortense.

Hortense Bioy: Hello, Emma.

Wall: So, you're here today to tell us about the importance of understanding what you're buying before you make a tracker fund or ETF purchase and this all comes down to the underlying market that that product is tracking. So, for example, a lot of people when they want to buy the U.K. market, look for a FTSE 100 tracker or ETF, but you're saying that might not always be the best choice.

Bioy: Absolutely. Absolutely. If you buy a FTSE 100 index fund or a FTSE 100 ETF basically what you are getting exposure to is only a 100 stocks which, yes, represent 85% of the U.K. stock market, but it is a bit narrow. I think if you want comprehensive exposure to the U.K. stock market, you would be better off with a fund that tracks the FTSE All-Share.

The FTSE All-Share has 600 constituents and represents 98% of the U.K. stock market. So, you're really buying the whole of the U.K. market. So, because it has 600 constituents, it is broader, it is also more diversified. It has a 20% allocation to small and midcaps, so it is less concentrated at the stock but also at the sector level. So, you don't get exposure, for example, so much exposure to energy stocks or mining stocks.

Wall: And that's not just the case in the U.K., is it? The same mistake is being made in Europe and in the U.S.

Bioy: Absolutely. I mean, if you take like the best known most widely followed benchmarks, like we talked about the FTSE 100 but also there is the CAC 40 in France, the DAX 30 in Germany or the in the U.S. the Dow Jones Industrial Average or even in Japan, the Nikkei 225. I mean, it's important to remember that those benchmarks were created by stock exchanges. So, they were originally designed to represent or to measure the performance of stock market and usually the large cap segment of a stock market.

And often, as you said, investors tend to associate these benchmarks with the market. They are saying this is the market. I would say while these indices are probably very useful to measure the performance of a manger, to evaluate its performance, it might not be the best ID for the long-term because these indices are not the best representation of the underlying market of the all the opportunity set and there are many more indices that are probably better representation of the asset class you're targeting.

Wall: So, then, for example, in the U.S. instead of the Dow Jones what should we be looking at?

Bioy: So, like a broader index would be the S&P 500, which as we know, has done very well in the past few years or even a U.S. total market index. These are better representation of the all asset class and is probably a better ID for someone who is looking for a broad exposure to the U.S. market.

Wall: And that's often how people use ETFs and trackers as well at the core of their portfolio where that diversification is of course very key. Perhaps you could give us a few examples of trackers and ETFs that do offer exposure to these broader markets.

Bioy: Yes, absolutely. I mean, I've got in front of me three examples of index funds that actually we rate Silver that gives exposure to the U.K. market and they track the FTSE All-Share. So, we have the L&G UK Index Fund; we have the BlackRock UK Equity Tracker; and the Vanguard UK All Share.

So, as I said, they are rated Silver and they track the FTSE All Share data. So, an ETF, the SPDR FTSE All-Share ETF that is quite cheap at 20 basis points. And for U.S. equities, we rate the Vanguard US Equity Index fund and it is rated Gold. So, it's a total market index and for the S&P 500, I would just name the iShares Core S&P 500 ETF which is very cheap here.

Wall: Hortense, thank you very much.

Bioy: Thank you.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
iShares Core S&P 500 ETF USD Acc USD532.22 USD-0.05Rating
iShares UK Equity Index (UK) D Acc277.02 GBP-0.60Rating
L&G UK Index I Acc383.50 GBP-0.05Rating
SPDR® FTSE UK All Share ETF Acc61.65 GBP-0.71Rating
Vanguard FTSE UK All Shr Idx Unit Tr£Acc252.46 GBP0.01Rating
Vanguard U.S. Eq Idx £ Acc889.84 GBP0.28Rating

About Author

Emma Wall  is former Senior International Editor for Morningstar

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