benchmarking against the UK STock market is a high-risk strategy, says edinburgh's Waugh
The UK stock market has become so highly concentrated that benchmarking against it is a high-risk strategy, according to Edinburgh Fund Managers. For that reason tracker funds and closet trackers will struggle this decade, according to Robert Waugh, head of UK equities at Edinburgh.
Waugh said if tracking the All Share index today, 53%, or more than half the investment would be concentrated into four sectors.
The largest, representing 18%, is banks. Although these companies are not currently expensive, said Waugh, there are concerns about bad debts given there have already been a number of early collapses in the cycle, for example Enron, Global Crossing and NTL, to name just a few.
Telecoms, which represents a further 11% of the All Share, has seen vast overcapacity and enormous investment with poor returns from 3G licences.
Oils represents 12%, of the All Share, while global growth in oil consumption is only about 3%. Pharmaceuticals, meanwhile, are obviously good companies but at great risk from patent expiries, Waugh said. This sector represents a further 12%.
Waugh said the concentration of the largest sectors has not been a problem until recently.
He added: 'The top four sectors on average accounted for 26% of the market between 1985 and 1995. The trouble is today they account for 53% of the market. This has happened mostly through acquisitions, not performance, for example Vodafone bought Mannesmann and, BP bought Amoco.'
At a stock level, tracking the All Share means 53% of a clients' money is going into 15 companies and a third of it is going to go into five companies. This cannot be considered a balanced portfolio, according to Waugh. 'The question is: do you think it is more risky to put 3% of your clients' money into Vodafone, or 8%. Common sense would say 3% is the less risky move. However, the measurement tools used in this industry compare risk with the All Share and therefore the lowest risk move is to put 8% into Vodafone. This is not something that seems particularly sensible to me.'
A further factor is that blue chips are not always safe bets.
'Aside from the many technology disaster stories, there are many other examples of large caps becoming small. Coates Viyella was once the second biggest company on the UK market. It is now a small comp- any capitalised at £330m.
Until last year, Enron was the seventh largest company in the US, but is now capitalised at nothing. BTR was once the twelfth largest company in the UK. Big does not always mean safe,' he said.
Back in 1965, the five largest companies in the UK stock market were Shell, ICI, BP, Marks & Spencer and BAT. A portfolio of just these five companies would have outperformed the market by nearly 30%, but the performance from each individual stock has been markedly different.
'The best performer, BAT, the tobacco company, would have returned almost 100 times the initial investment.
'M&S would have returned 24 times your money, however ICI would have made a return of just three times, which against inflation is an atrocious return.'
Edinburgh's £61m UK Growth fund occupies 109th position in the UK All Companies sector of 288 funds in the 12 months to 27 February, according to Standard & Poor's, with offer-to-bid returns of -15% compared to a sector average of -17%.
The group's UK Smaller Companies fund, £68m in size, has slipped to a ranking of 70 out of 73 funds in the same period.
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