How To Pick A Product: UK Large Caps

Large caps have recently underperformed smaller caps but still offer access to global markets and dividends  

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Reviewed by: Jennifer Hill
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Edited by: Jennifer Hill

Large caps have lagged smaller companies in recent years. The FTSE 100 has underperformed the FTSE SmallCap index by an average of 6 percent per year over the last five years, according to Financial Express.

Nevertheless, investors often prefer larger cap funds because of dividend stream (the FTSE 100 yields around 3.5 percent) and access to global markets (more than half of the revenue in the FTSE 100 is derived overseas).

What is the best way to access this asset class: an exchange traded fund (ETF), traditional index tracker, active fund or investment trust?

 

ETFs

The UK is the world’s third largest market, behind the U.S. and Japan, and is one of the most heavily researched. This means it’s pretty efficient, which makes it difficult for active managers to find bargains and lends itself to passive investing.

ETFs are good for liquidity and come at low cost. There are more than 100 UK equity ETFs. For those who want to invest solely in the FTSE 100, offerings by Amundi, ComStage, HSBC and iShares are worth considering.

Adam Laird, head of passive investments at Hargreaves Lansdown, said: “iShares [Core] FTSE 100 UCITS ETF is one of the most liquid and low-cost options with ongoing charges of 0.07 percent per annum. It’s a simple way to track one of the UK’s best-known indices.”

Ben Yearsley, a director of Plymouth-based Shore Financial Planning, uses this ETF to get quick access to large caps. “If you want pure UK large cap exposure then an ETF is your best bet,” he said. “Personally, as a long-term investor I prefer active funds, but I often use a FTSE 100 ETF as a shorter-term investment when I think the market is due to bounce, maybe after a period of sustained losses. I use the iShares Core FTSE 100: it does what it says on the tin.”

Ian Head, owner of Berkshire-based adviser Fund Management, highlighted “more interesting variants”, such as the db X-trackers FTSE 100 Equal Weight UCITS ETF, which allocates each constituent of the FTSE 100 index a fixed weight of 1 percent when the fund is rebalanced twice a year.

“This offers an opportunity to invest in an offering a little more sophisticated than a straight tracking fund,” said Head.

 

Index Tracker Funds

The downside of a tracker over an ETF, according to Yearsley, is forward pricing.

“It can be a pain and I prefer ETFs as you know the price you’re getting. However, if an open-ended FTSE 100 tracker is your chosen option, check tracking error and then price.”

Darius McDermott, managing director of Chelsea Financial Services, pointed to a lower tracking error in this asset class when compared to others.

“It’s easier to fully replicate this part of the market: you don’t need to worry about a ‘tail’ of smaller companies as you would in the All-Share, so the tracking error is much smaller. L&G, Fidelity and HSBC all have funds of this ilk.”

There has been a price war recently among passive fund providers, making FTSE 100 trackers fiercely competitive. Yearsley likes the BlackRock 100 UK Equity Tracker for its “extremely low” charges of 0.51 percent.

There are also a number of so-called ‘smart beta’ trackers in this space. Head is “watching with interest” the Investec Qtrac UK Controlled Volatility fund. It aims to provide long-term capital growth while minimising risk by mirroring the performance of the EVEN 30 index, which tracks the 30 least volatile stocks from the 100 largest companies listed on the London Stock Exchange.

“The 30 constituent stocks are re-selected on a monthly basis and each stock has an equal weighting within the index,” said Head. “To ensure that risk remains low when markets are particularly volatile, the EVEN 30 index features a volatility control which allows the index to partially disinvest from its 30 constituent stocks.

“Like many advisers, I prefer to invest in funds with a proven track record, but this one is definitely on my watch list, with back-tested data looking very interesting.”

 

Active Funds

A big benefit to using an actively-managed fund is that these vehicles can avoid certain sectors, like banks in 2008/09 or oil and mining companies more recently.

“Both of these sectors make up a significant part of the market and you simply have to hold them if you own an index fund,” said McDermott.

However, many active UK fund managers use their investment flexibility and have up to 20 percent in overseas stocks: finding a pure UK large cap fund isn’t that easy. Finding one that tends to outperform the market is even harder.

“It’s harder to have an edge when everyone has the same, detailed information to go on,” said McDermott.

“Having said that, there are some great managers in this space who have managed to do exactly that on a consistent basis. Richard Buxton, now managing the Old Mutual UK Alpha fund, and Steve Davis, manager of the Jupiter UK Growth fund, are two such examples. “Richard is very keen on the mega-caps at the moment as he thinks they are showing the best value.”

About 80 percent of Old Mutual UK Alpha is currently invested in companies with a market capitalisation of more than £3 billion.

Yearsley also likes Buxton’s fund. “He often buys into contrary sectors and positions, meaning his performance is often very different to the index. One challenge for him is that he has recently been named CEO of Old Mutual Global Investors – not many have managed to combine the role of CEO and top fund manager.”

 

Investment Trusts

With only 16 investment trusts in the UK All Companies sector investors have far less choice among closed-ended funds, but data from the Association of Investment Companies (AIC) shows that these funds have outperformed their open-ended peers over five and ten-year periods.

“The freedom to gear to enhance returns is clearly a factor, since in a rising market it can produce an additional boost to performance,” said a spokeswoman for the AIC.

Head highlighted the Henderson Opportunities Trust and the Fidelity Special Values for their solid performance, though noted that neither trusts invest exclusively in large caps.

Eight out of Keystone Investment Trust’s top ten holdings are FTSE 100 stocks. “This fund has a good performance record and is available at a 10.1 percent discount to NAV [net asset value],” added Head.

Meanwhile, Yearsley likes Schroder UK Growth. “Managed by Philip Matthews this is the pick of the bunch, though only 70 percent is currently invested in FTSE 100 companies,” he said.