The Perils of Buying and Index Tracker
The difficulty of selecting suitable shares for a portfolio and receiving decent returns are well documented and recently it has been, dare I say, fashionable to opt out and buy an Index Tracking fund instead. The idea, first postulated in the early Seventies is that by simply buying shares to replicate those in a suitable index, an investor will receive market returns without having to employ costly research or fund managers. So, instead of paying an Annual Management Charge of 1.5% plus additional costs of about the same, i.e. 3% a year, you could get similar returns for less than a sixth of the cost.
So far so good, and over the last decade, in particular, this style of investing has really gained popularity. But what is an index and is tracking one always a good idea?
Nowadays, we are all pretty familiar with the idea of an index giving us an idea of movements in the market but not all indices are equal. You only have to follow the residential property market to realise there are a few and they can show very different results. An index samples transactions, how many of them there have been and at what price. The producers of the index can then state that the market has changed by a given percentage and we can gauge its health.
The problem is, you have to define the market. Over 3,000 companies are listed on the London Stock Exchange but the fortunes of some are more important to more people than those of others. Companies like Shell and Vodafone are important to many thousands of investors as their pensions may well hold their shares but some companies have very few shareholders and share deals happen very rarely.
The usual answer is to weight their importance in an index according to the market value, or capitalisation, of the company. The other common way of selecting for an index is only to include, for example, the 100 biggest stocks, those which are usually traded most often by most people. This is how the FTSE100 Index, the most important London index, is created.
So, you buy a fund which tracks the FTSE100 and you get a nice, well diversified portfolio without any hassle. Not quite. The FTSE100 has its own sharks and minnows and the 15 biggest companies comprise half of the portfolio by value. Not quite the result most investors are looking for. Also, about a third of the companies listed are in commodities and natural resources, so it’s packed full of oil producers and mining companies, which hardly feels representative of the investment market as a whole. The problem seems to be getting worse as these companies ride the commodity boom and attract others to list in London. Also, many of the companies are behemoths which are unlikely to attract much takeover interest, a traditional driver of share price rises.
Other Global markets suffer from similar problems but all is not lost. For those keen to index their way to their fortune, and I am a proponent of indexing, it is possible to construct a portfolio of index funds which can give you decent market coverage without too many distortions and the number of products available to help grows by the week.
Posted by:
Scott Taylor Posted Date: Monday, 20 June 2011 12:48
Being part of one currency requires a willingness on all parties to endure pain together and this is a lot easier where there is political union, such as in country, rather than just a committee. Countries work much better to the common good and are able under one government to move money from areas of excess to areas of shortage using taxation. The wealthy seem to be happier to support the poor when they share one government.
If you take the Euro Zone, it would seem that the common ideal of a united and mutually beneficial Europe is proving to be a little too abstract an idea for the rich easily to swallow the notion of supporting the poor. Greece is broke and may never be willing to suffer the hardship required to repay its debt, certainly within the time originally agreed. Ordinarily, a country with its own currency would either suffer a devaluation, which boosts its economy and allows repayment of its debt with overseas investors having suffered loss through the devaluation. In other words, the pain is shared and everyone gets over it. Alternatively, a country, much like an individual or company, may just throw up its hands and admit defeat. It then goes bankrupt, an agreement is reached about how much can be repaid across the creditors, who share the pain equally (in theory, at least), and everyone gets over it. Once the crisis is over, the country is usually forgiven (Iceland already has been) and returns to the market to borrow more money with unseemly haste.
This cannot happen when countries share a currency but not the debt and are not united politically. In fact, so entrenched is self-interest in Europe, that it is a wonder that anything is agreed.
It is almost certain that the wrong decision will be made and far too late. The Greek debt crisis should have been resolved months ago. Any solution with any chance of success will involve the richer members of the Euro paying to bail out Greece, their politicians just have to work out a way of persuading their electorates to support it. Greece cannot leave the Euro, no mechanism was included to permit such a thing, and it cannot repay its debt without leaving. No prizes for guessing what will happen.
So, Greece will default. A little at first, and then a lot, but it will default. This will place many European banks in a bit of bother as they own this debt. So Germany, France and perhaps even the UK will have to shore up their banks all over again. The Greek government will have no choice but to give in to their rioting electorate.
Of course, if the Greeks were more receptive to paying tax and the Germans keener on shopping, the Euro would be a lot more easy to manage.
