Whether you’re saving for retirement, looking to pay off your mortgage or any other future objective, investing in equities has been one of the most successful ways of generating long-term value creation. According to data from Bloomberg from April 2023, global equities, represented by the FTSE All-World Total Return Index, have grown by 57.3% over the past five years, smashing the returns from cash and bonds despite the recent cycle of interest rate hikes over the past 18 months or so, typically good for the latter two.
This during a period of chaos created by a global pandemic, a new war in Europe and other destabilising events. Gold, the ultimate investor safe haven, increased 66.7% over the same period.
As the chart overleaf shows, this outperformance of equities over cash, bonds and commodities is no one-off – it’s the same story over 10, 15 and 20-year timeframes.
EQUITIES HAVE MASSIVELY OUTPERFORMED
Looking at it another way, using a hypothetical example, if you could have invested £10,000 in the global equities market 20 years ago, your investment would be worth more than £71,000 today. That’s more than three times the amount you would have had from investing in bonds, more than four times as much from commodities or nearly five times as much as if you had kept that £10,000 in a deposit account.
But as most of us already know, share prices have a nasty habit of going down as well as up. This might be because of a dry spell of trading, stiffening competition in key markets, poor use of capital, wider macroeconomic issues or a thousand other things, and sometimes it is not easily to explain what or why.
That’s where diversification comes in. Spreading your money across many equities can help smooth the ups and downs compared to backing single stocks and investing in stock market indices via ETFs (exchange traded funds) is an easy and low-cost way to get instant diversification.
When you spread your investments around, you’re increasing the probability of capturing the stocks that do well, and the idea is that they compensate for any that don’t perform as well. In theory, investing in 100 stocks should even out the returns compared to putting all your money into just one stock, and investing in 1,000 should be better than 100. Similarly, if you only invest in the stocks of one type of company, let’s say the major supermarkets in the UK, it doesn’t matter how many you invest in if they all perform the same. If one goes up, they may all go up, and the same on the way down.
Meaningful diversification requires investing in different types of companies, of different sizes, and from different parts of the world. Every country goes through cycles, where its economy expands for a period of time and then eventually contracts before recovery and expansion kicks in again.
It’s worth noting that there is a counter argument, that too much diversification can end up diluting your best performers with average or poor ones. No system is perfect so finding your own scale and shape of asset spread is important, but on principle, diversifying your portfolio should help you accumulate wealth over time without keeping you awake at night.
DIFFERENT INGREDIENTS, UNIQUE FLAVOURS
Not all indices are created equal, and their individual ingredients can give one a completely different flavour to another. For example, in
2022 financials and consumer staples were the largest sectors of the FTSE 100, making up roughly 35.7% of the index weighting, a measure of the collective market caps measure as a percentage
of the total.
Those same two sectors represented 17.7% of the S&P 500. Similarly, information technology stocks in the US index had a weighting of 28.1%, thanks to the enormous market valuations of Apple (AAPL:NASDAQ), Amazon (AMZN:NASDAQ), Microsoft (MSFT:NASDAQ) and others. The FTSE 100’s equivalent sector weighting was just 1.3%, a major reason why UK equity markets have underperformed the US and elsewhere over the past decade or more.
So, let’s dive in. Here Shares presents the indices that we believe are the most important for investors to keep tabs on. We discuss how each index is created, some of the major constituents, and some of the differences that investors should be aware of and products which track them. We start with the MSCI World.
MSCI WORLD
The MSCI World index is made up of approximately 1,512 constituents and tracks the performance of large and mid-cap companies in 23 developed markets worldwide.
The top constituents of the MSCI World Index are heavily weighted towards the technology sector – 22.1% in fact – and it could be argued that there is little difference between this index and the constituents that make up the US S&P 500.
Apple (APPL:NASDAQ), Microsoft (MSFT:NASDAQ) and Amazon (AMZN:NASDAQ), all from the US technology sector feature, in the top three constituents in the MSCI World Index.
Health care and financial services companies also make it into the top 10 constituents in the form of UnitedHealth Group (UNH:NYSE) and JP Morgan Chase (JPM:NYSE) with 0.81% and 0.79% weightings respectively.
Financials make up 14.9% of the index and healthcare 12.5% overall. However, the MSCI World does include stocks from outside the US, providing a measure of geographic diversification – among the largest being Novo-Nordisk (NOVO-B:CPH) and Nestle (NESN:SWX).
There are lots of ETFs tracking the MSCI World, one example is iShares Core MSCI World UCITS ETF (SWDA) which has an ongoing charge of 0.2%. [SG]
S&P 500
Outside of a general global index, many would argue that the S&P 500 is the index for investors to be exposed to. We all know it is dominated by big technology firms like Apple, Microsoft, Google parent Alphabet (GOOG:NASDAQ), and Nvidia (NVDA:NASDAQ). Tech makes up about 30% of the S&P 500 in terms of market capitalisation, yet the index represents far more than just tech.
Healthcare (14%), financials (12%), consumer discretionary (11%), industrials (9%) and communications (8%) give investors a wide spread of industry exposure, many of which have attractive long-run fundamental growth attractions. Think megatrends like shifting demographics (healthcare, consumer discretionary), a changing world order (communications, financials) and a bumpy energy transition and climate change (everything?) and you get the drift.
On that basis, every investor should want long-term exposure to the likes of Visa (V:NYSE), Pfizer (PFE:NYSE), Procter & Gamble (PG:NYSE), Coca-Cola (KO:NYSE) and Colgate-Palmolive (CL:NYSE), and who wouldn’t want a bit of Warren Buffett’s Berkshire Hathaway (BRKb:NYSE) stashed in their portfolio. An example S&P 500 ETF is iShares Core S&P 500 (CSPX) which has an ongoing charge of 0.07% [SF]
NASDAQ COMPOSITE
Nasdaq is the second-largest stock exchange on earth, after the NYSE, and it operates two of the most closely watched benchmark stock indexes – the Nasdaq Composite and the Nasdaq 100. The Nasdaq Composite tracks the performance of more than 2,500 stocks listed on the Nasdaq exchange, and given the high concentration of technology firms, it has become widely accepted stand-in for the performance of the overall tech industry. It
also means that there is significant overlap with the S&P 500.
For example, coined the ‘Magnificent Seven’, Apple, Amazon, Alphabet, Microsoft, Meta Platforms (META:NASDAQ), Nvidia and Tesla (TSLA:NASDAQ) make up about 27% of the S&P’s rough $15.5 trillion market value.
As a market-cap-weighted index, each company included in the Nasdaq Composite is weighted based on its total market capitalisation, or the market value of its outstanding shares. Big companies with larger capitalisations therefore have a more significant impact on the index’s performance than smaller companies. Xtrackers Nasdaq 100 (XNAQ) offers exposure to the biggest names on the index for an ongoing charge of 0.2% [SF]
DOW JONES INDUSTRIAL AVERAGE
Once the key US benchmark, the Dow Jones Industrial Average is also one of the US’s oldest, founded in early 1885 by Wall Street Journal editor and businessman Charles Dow. But it has fallen
out of favour as a benchmark in recent years for several reasons, not least because it tracks only 30 companies.
Contrary to common belief, the DJIA does not contain the 30 largest publicly listed US companies, but rather a selection of large constituents selected by a committee on a price weighting basis. This means Dow companies have among the highest share prices of US listed stocks, not necessarily the largest market capitalisations, which can leave performance skewed to companies that have resisted the temptation to split their stock over the years.
So, no Alphabet, no Amazon, no Tesla, no Colgate-Palmolive, no PepsiCo (PEP:NASDAQ). It lends critics ammunition to claim that it simply fails to reflect the US economy. Relevant products are thinner on the ground than for other US indices but iShares Dow Jones Industrial Average (CIND) is available at an ongoing charge of 0.33%. [SF]
FTSE 100
A market cap-weighted index of blue-chip companies, the FTSE 100’s performance has paled in comparison to the major US markets such as the S&P 500 and Nasdaq over recent years. This underperformance reflects investors’ hunger for the exciting go-go-growth stocks and mega cap tech names that are notably absent from the FTSE, an index dominated by dependable income-paying stocks and offering a yield of 3.7% according to the latest data from FTSE Russell. Year-to-date, the FTSE 100 is down 2.7% at 7,350.3 points whereas the S&P 500 is up more than 16% at 4,439.1 points and the Nasdaq Composite is some 30% ahead at 13,594.
In terms of themes, the FTSE 100’s largest weightings are to the health care, energy and banking sectors, which means key stocks driving the index are the likes of vaccine-maker AstraZeneca (AZN), banking behemoth HSBC (HSBA) and the oil and gas giants Shell (SHEL) and BP (BP.).
Other sectors with index heft include Personal Care Drug and Grocery Stores, the domain of Sure deodorants-to-Magnum ice creams maker Unilever (ULVR) and Nurofen, Durex and Dettol supplier Reckitt Benckiser (RKT), and also Food Beverage and Tobacco, home to drinks giant Diageo (DGE) and British American Tobacco (BATS). In the basic resources sector, you’ll find miners Rio Tinto (RIO) and Anglo American (AAL).
It is worth noting that the FTSE is no proxy for the domestic economy, since index constituents generate roughly 70% of their sales outside of the UK, giving investors a healthy degree of geographic diversification. Among the low-cost ETFs enabling investors to track the
FTSE 100 include the likes of the Vanguard FTSE 100 (VUKE), the iShares Core FTSE 100 (ISF) and the Lyxor FTSE 100 ETF (L100). [JC]
STOXX Europe 600
The broadest and most representative European stock index is the STOXX Europe 600 which tracks the return of the largest stocks in 17 European countries including the UK, Switzerland and Scandinavia.
Stocks are included based on their free-float market cap, and the index is reviewed every calendar quarter.
The market value of the index at the end of July was €12.88 billion, while the free float of the index was €10.08 billion.
The largest stock in the index had a market cap of €299 billion and a weighting of 3% while the smallest company had a market cap of just €1 billion.
Year-to-date the index has gained 13.8%, while over 1 year it has returned 11.1%, over three years 44.7% and over five years 40.3%.
Interestingly, annualised volatility has fallen in that time from 17.9% over five years to 15.7% over three years and 14.1% over one year, while year-to-date it is lower still at 12.4%.
The biggest weightings are in health care, where Switzerland and the UK account for a high proportion of companies; industrials, where German firms are well-represented; banks, where the UK, Switzerland, France, Spain and Italy have large weightings in financials; and food, beverages and tobacco where again the UK, France, Spain and the Netherlands make up most of the sector allocation.
Like the FTSE 100, it has a relatively low weighting in technology stocks compared with the US indices, but at 7.4% it is still significantly higher than the weight in UK Index.
The biggest ETF, and the cheapest in terms of fees at just seven basis points, is the €6 billion market cap Lyxor Core STOXX Europe 600 (MEUD). [IC]
NIKKEI 225
The Nikkei 225 is Japan’s premier stock index. It has a few idiosyncrasies, most notably unlike most major global indices it is weighted by price as opposed to market value. It encompasses the performance of 225 large, publicly owned companies from a wide range of industries which are listed on the Tokyo Stock Exchange.
There’s a semi-annual review of the index every April and October and criteria for inclusion include the price of the stock, how easy it is to buy and trade and, interestingly, sector balance.
The current list of top constituents is unlikely to be immediately familiar to Western eyes, Softbank (9984:TYO) may have some name recognition given its ownership of ARM, the Cambridge-based microchip designer which it purchased in 2016 after the Brexit vote made it and other UK-listed stocks vulnerable to overseas bidders, and which it is currently preparing to list in New York.
Fast Retailing (9983:TYO) may not ring too many bells but its premier retail brand Uniqlo has branches in the UK. It doesn’t come as a major surprise to discover technology is the leading sector by some distance, accounting for nearly 50% of the index.
For decades Japan has been at the forefront of innovative technologies, notably robotics in the 21st century. A combination of Abenomics, economic reforms introduced by the late prime minister Shinzo Abe, and shareholder friendly moves by Japanese companies has helped drive much improved performance for the index over the last decade.
Exchange-traded funds tracking the Nikkei are rare but there is Xtrackers Nikkei 225 (XDJP) which has an ongoing charge of 0.09%. More commonly the MSCI Japan index is tracked, including by iShares Core MSCI Japan (SPJA) which has an ongoing charge of 0.15%. [TS]
HANG SENG
The Hang Seng is the main index for Hong Kong listed stocks. Because Hong Kong shares are easier to trade for overseas investors than those traded in mainland China, this market tends to dominate discourse around Chinese equities.
The top names by weighting may well be familiar to UK investors – they include Chinese internet firms Alibaba (9988:HKG), Tencent (0700:HKG) and a company which also has a listing in the UK in banking outfit HSBC (0005:HKG).
The index recently entered bear market territory (a fall of 20% or more from its most recent peak) as it was hit by Chinese property woes plus, more generally, the faltering recovery of China’s economy post the lifting of zero-Covid measures.
The Hang Seng has a small number of constituents relative to some other global indices at just 80. They traded on an average price to earnings ratio of 12.3 times and offered a yield of 3.3% as of 31 July 2023. They are a mix of stocks specifically listed in Hong Kong and mainland China shares.
Financials is the dominant sector, reflecting Hong Kong’s historic status as a centre for banking and insurance with technology coming in a close second.
Investors are not well served by vehicles offering direct exposure to the Hang Seng. There is one product which offers specific exposure to the tech names in the index: HSBC Hang Seng Tech (HSTC) though the ongoing charge is high for an ETF at 0.5%. Franklin FTSE China (FRCH) offers exposure to a lot of the names in the Hang Seng for an ongoing charge of 0.19%. [TS]
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