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Get on the right track

I have considerable exposure to the FTSE 100 index through structured investments and tracker funds. I have more capital to invest and would like to retain a UK focus. I have been considering an Oeic tracking the UK All Companies index or one that concentrates on the FTSE 350 rather than just the FTSE 100. However, I am concerned that this might give me a significant degree of overlap, with too much exposure to the top 100 UK shares. Can you tell me how the All Share and other indices are made up so I can ascertain the potential degree of overlap?

I would query the logic behind your preference for index trackers. However, in response to your specific questions, each FTSE index is constructed to reflect stocks of different market capitalisations. The FTSE All Share index represents around 99 per cent of the total UK market capitalisation.

The FTSE 100 covers the 100 biggest stocks as measured by capitalisation, with the FTSE 350 representing the top 350. It is a common misunderstanding that the FTSE 250 index follows the same logic but in fact it represents the next 250 stocks after the top 100, so the 350 is a combination of the 100 and 250 indices.

The FTSE Small Cap index covers the 340 or so stocks at the smaller end of the scale. The 1 per cent of UK shares listed on the FTSE which do not feature in the All Share are often in their earliest stages of development and highly illiquid. These are covered by the Fledgling index.

The oldest of the FT indices is the FT Ordinary Share index (FT30) which consists of 30 shares in leading UK companies. In contrast to the other indices where the constituent companies are selected purely on size, the companies in the FT30 are selected as a representative cross-section of UK industry. Unlike the other common indices, each share in the FT30 counts equally regardless of market capitalisation.

The last of the main FTSE indices is the FTSE All Small index, which is a combination of the 900 or so stocks represented by the FTSE Small Cap and FTSE Fledgling indices. There are a number of other indices such as the FTSE Techmark All Share and FTSE TMT which tend to select stocks from the major indices and group them on a sectoral basis.

As you can see, the All Share covers around 700 companies. However, it is important to appreciate that the FTSE 100 does not represent one-seventh of the All Share index as the indices are based on market capitalisation. It may come as a surprise that the FTSE 100 does, in fact, make up around 80 per cent of the All Share index, with the 250 index representing approximately 18 per cent and the Small Cap index only 2 per cent. What might be even more surprising is that the top 10 stocks by market capitalisation represent more than 45 per cent of the FTSE All Share.

Therefore, an investment in an All Share or 350 tracker will certainly lead to a high degree of overlap between the current investments, with significant increased exposure to the top 10 companies. Accordingly, a fund that invests in stocks within the 250 index (which represents approximately 18 per cent of the UK market by capitalisation) and excludes the top 100 stocks will seem to be a reasonable complement to your existing portfolio.

The HSBC FTSE 250 index tracker would undoubtedly meet those requirements. However, as I inferred earlier, index trackers have their limitations, namely, that while they track the index, they fail to fully benefit from the accrual of dividends because they do not necessarily fully replicate the index. Even funds that do fully replicate the index will not receive the full benefit of the dividends as the cost of holding and managing the portfolio will eat into the growth. For example, the total return with income reinvested at payment date for the HSBC 250 index tracker over the 60 months up to June 30 was -7.8 per cent – slightly better than the -9.8 per cent registered for the actual 250 index. This is acceptable until we look at the return for the index with accrued dividends, in this case, 3.8 per cent.

In a period of steady economic growth, income will be of significant importance. I would also propose that flexibility will be of equal importance. I suggest that the use of an actively managed fund investing in the 250 index which benefits from accrual of dividends will provide superior returns. My preferred fund would be Schroder UK Mid 250 which was launched in November 1999 and has outperformed the 250 index for most of the time since.

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