The above statement is not something you would hear from your doctor, but in certain matters it is true
In the world of investment, being overweight implies a confidence in an area to outperform the alternatives. This could be a bias towards one country’s stock market e.g. being overweight to America, or overweight to utility companies compared with their relative value on the stock market. An investment manager’s opinion will change as time progresses and new information or circumstances emerge.
The manager can then react accordingly. An index tracker cannot use knowledge or common sense to be overweight or underweight in anything. It simply tracks its index, for good or for bad. Take the S&P 500 index in America. As the name suggests, it is made up of the largest 500 companies in the US by value. Tracking it over the last 12 months would have given excellent returns but 25% of it is made up of just five mega-cap technology companies. Facebook, Amazon, Microsoft, Netflix and Alphabet have all grown dramatically but now their valuations look very stretched. Are they due for a correction?
In a tracker, regardless of whether or not there is value there, you have to hold them. Another area, and even more important in my view, is that an index tracker cannot bias smaller and mid-sized companies. If you invest in a FTSE All Share tracker, it will mimic the index exactly which means that you do not have exposure to the whole UK market. There are around 2000 companies traded on our exchange, but the index tracks around 640 of the largest ones. Of that, around 83% is accounted for by the FTSE100 companies, the largest by stock market value. So, why do I say that choosing your exposure to company size is important? Let us consider actual performance. The figures below are for the last 12 months, at the time of writing, and take us from the point when markets were bouncing back after the initial shock caused by the pandemic and lockdown. FTSE 100 up 22.39%, including dividends. FTSE All Share up 25.98% FTSE Mid 250 up 35.30% FTSE Small cap up 55.86% *Source FTSE Russell You would certainly wish to be overweight to smaller companies over that period. But is it a flash in the pan? The short answer is “No”.
The Nobel Laurate, Eugene Fama, and his colleague and fellow academic, Ken French, carried out extensive research into stock market returns going back many decades. To cut a long story short, they discovered that smaller companies outperform larger ones over time. It may not be the case that every year this happens, but more often than not it will. This is also persistent in all developed stock markets. This is why we at Rutherford Hughes bias our equity strategies towards mid-sized and smaller companies. Our clients have been very pleased with this approach and, Dear Reader, we would be happy to prove it to you. If you would like more information, or would like to discuss your own position, then please do not hesitate to contact me or my colleagues, David Hughes and Denise Graham. Peter Rutherford is a director at Rutherford Hughes Ltd. He can be contacted on 0191 229 9600 peter.rutherford@rutherfordhughes.com www.rutherfordhughes.com
