It’s conventional wisdom that index trackers are the best way to invest.
Just lump your money in a low-cost, liquid and simple, size-weighted index that tracks the FTSE 100. It’s an approach that has given market access to millions of investors, many profitably. The $5 trillion invested in portfolios tracking size or ‘cap’ weighted indexes tells you how significant they are.
There’s just one problem.
Like so many things that ‘everyone knows’, for the last ten years, passive investing tracking has been one elephant-sized waste of time.
You see, our Great British stock market has soared 51% since it hit bottom eight months ago. Yet this windfall rally leaves investors still 17% down on where they were a decade ago.
Between 26 November 1999 and 23 November 2009 the FTSE 100 index of leading shares shed exactly 1104.7 points. On an investment of £1,000, that translates as a £201 loss.
It could be worse, you may surmise. Yes, it could. Factor in management costs (1.5% a year) and inflation (2.8% a year) and you’ve lost another £478. Over the last decade buying the FTSE has been akin to putting your money under the bed. And then reaching under the bed every few months and tearing up a £50 note.
We’re going to show you how to beat the tracker trap, but first we’ll explain how we got here…
Where did it all go so wrong?
After all, the FTSE rose some 250% in the previous decade. Anyone looking at the comparison has every right to feel hard done by. Investors between the 80s and 90s had a much easier time than between the 90s and 00s. But that is where we are.
And, index tracking, in the UK, is dead.
It’s easy to explain. Fans of Kondratieff waves, a Russian theory of long-term economic cycles – would note that the UK is in its ‘Stagnation’ phase.
However, you don’t need to be an economist to realise that the UK is a developed, mature economy. Our economy’s long-term growth phase is behind us. As is our stock market’s.
In comparison with the BRIC ( Brazil, Russia, India and China) economies, our stock market has actually begun shrinking relative to the size of the economy.
In emerging markets, tailwinds of rising domestic demand, increasing reliance on stock markets as a source of funding are driving these countries’ stock markets ever higher.
No further for the UK to grow – Stock value as a % of GDP
Source: World Bank, Goldman Sachs
The UK meanwhile, has been on the slide for the last 14 years.
You need to be discerning to make money.
That’s where the ‘fundamental index’ comes in.
“A better way to invest”
What is the fundamental index?
It’s so simple, you’ll be amazed it doesn’t already exist.
It’s a method that allows you to invest not in the 100 biggest companies lumped together, but the 100 (or so) firms with the strongest fundamentals
Rob Arnott is the head of Research Affiliates, a California based investment research firm with $25 billion under management and rising every year. In 2002, in the wake of the dot com bubble, Rob created an index to reflect common sense, not accepted principles.
The result was the fundamental index.
It has the benefits of rigorous stock picking methods normally associated with an active fund manager.
How has this approach fared?
Rob’s research of 46 years of market ups and downs has shown how much better fundamental indexing has performed. An investor contributing £1,000 year into this strategy would have £2,000 more than could be attained by investing in the FTSE over a ten year period. After 20 and 30 years the gap soars to £126,000 and £504,000.
Of course, the fundamental index will not outperform every month, every quarter or every year. But it’s a logical system based on common sense.
There are 103 companies that meet the winning formula taking dividends, revenue, cash flow and book value over the last five years. This gives a picture of average income, relative balance sheet strength and what the growth potential is of every stock in the FTSE All Share.
Five of the top recommendations include:
BHP Billiton,
BP,
HSBC,
National Grid,
Wolseley
It doesn’t sound very exciting on the face of it. But these ‘fundamental index’ selections have outperformed rising markets 80% of the time, and falling markets 88% of the time over the last 23 years.
It’s a sensible way to protect yourself from another missing decade in trackers. This is a much needed dose of good common sense for today’s volatile markets.
Best wishes,
Theo Casey
For The Right Side
P.S. Theo Casey is the editor and investment director of The Fleet Street Letter. In his latest issue, Theo presents a little-known solution for investors wishing to follow the fundamental index ethos to the letter. He has found a fund that has practiced these exact principles to fantastic effect over the past few years. To receive this as well as the rest of Theo’s tips, click here.
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