The big problem with simple FTSE 100 tracker funds is that they mimic the make-up of the FTSE 100 index by weighting.
That means that an investment in the FTSE 100 is skewed to the fortunes of the largest constituents of the index.
Right now, the last place I would put my money is into the big firms in the index, so the prospect of an over-sized allocation of my capital to the very firms I would avoid makes a FTSE 100 tracker fund look unappealing to me.
Where the money goes
The largest constituent of the FTSE 100 by listed market capitalisation is banking firm HSBC Holdings, which represents around 5.8% of the index. There are five big banks listed in the index and collectively they account for about 13.4% of its value.
Meanwhile, oil company BP accounts for 3.8%, but adding the four big oilers in the index together reveals that they make up 11.5%, even now that their shares have fallen so far.
So, around 25% of an investment in a FTSE 100 tracker fund now will be allocated to the big banks and big oil companies, both of which are highly cyclical sectors. Such is the skew to the bigger constituents of the FTSE 100 that about 71% of the money we invest in a FTSE 100 tracker goes into just 30 companies. Focusing down on the 10 largest firms reveals that they draw 38% of our invested funds.
So the fortunes of the few have a disproportionate impact on the performance of most of the money invested in the fund. That strikes me as a potential missed opportunity and a risky investment strategy.
How would you invest?
I would argue that the least cyclical firms, and the companies with the most appealing growth prospects, reside among the 70 or so that only receive 29% of our capital.
Right now, Im not keen on cyclical sectors such as oil, banking, miners and other financials such as insurance firms. Those that have fallen (oil, miners and banks) look weak and Im not keen to bet on the possibility of any rapid resurrection to previous glories. Meanwhile, those sectors that remain at lofty highs, such as financials, insurance firms and housebuilders, seem vulnerable. Maybe their day of reckoning is on the way.
The cyclicals as a whole account for almost 50% of the FTSE 100s overall market capitalisation. Thats a big problem for me because I prefer defensive investments such as consumer good firms, or companies with a strong and well-defended trading niche and plenty of growth potential. So Im not keen to tie up around half my investing capital on the unpredictable seesaw movements of the cyclicals.
Thats why investing in a FTSE 100 tracker fund is off the agenda for me at the moment. Those looking for a passive investment could search out a fund that replicates the constituents of the FTSE 100 and then allocates capital in equal weight to each one.
Kevin Godbold has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.