Diversification is the way to achieve long-term returns
Jeremy Stewart is head of wealth management and private banking at Danske Bank
From a poor start, most equity markets finished last week with a partial recovery of lost ground, but the themes that have been with us for some time continued to dominate, namely the prospects for the Chinese economy, global growth and the future for interest rates.
Against that backdrop, it is not surprising that over the past year the performance of the FTSE 100 share index has been disappointing, coming in with a loss of 9%. For the longer-term investor, the returns are still well into positive territory, although there is an interesting sub-plot. In contrast to the index representing the UK's top 100 companies, the FTSE Mid 250 index has provided investors with a gain of nearly 9% over the same period. That is a difference of 18% over one year.
The FTSE 100 is dominated by a few large companies, particularly in the mining, oil and banking sectors. It could be argued that if an investor focuses heavily on FTSE 100 companies, they are automatically increasing their risks by having insufficient diversification in their portfolio.
Mining and oil stocks, for example, represent close to a fifth of the index, and their recent performance has been a massive drag on the index. Part of the solution is to diversify across a wider range of businesses and ensure that there is a more balanced exposure to different sectors, not dominated by a few companies. This brings us to the FTSE Mid 250 index.
The FTSE 250 is much less dependent on a small number of large companies and it also has a wide exposure to growth stocks, which is maybe one of the reasons why this index has produced better returns over the last 12 months, the last five years and indeed over the last decade. This does not mean that investors should rely exclusively on mid 250 companies.
In the downturn that started in 2008, some of the larger global companies in the FTSE 100 proved to be more of a 'safe haven' for investors and oil and mining stocks will recover at some stage. However, over the long-term, the UK companies in the FTSE Mid 250 index have often produced better returns, on aggregate, than those in the FTSE 100 index.
As ever, the discipline of diversification across asset classes, financial instruments, sectors and geographies, is the way to achieve balanced long-term returns. Saying that, it is also really important to look behind the headlines.
This is especially true for 'passive investing'. Both locally and globally, there has been a surge over the last decade in what is called 'passive investing', whereby investors use low-cost index tracking funds on the basis that many investment managers fail to beat the performance of the relevant indices. For these investors, it is arguably even more important to realise that not all indices are created equal.