Index trackers may not be as diversified as you think

The whole market is on sale, 30%+ below its high.

So it doesn’t matter what you buy, you can just buy a tracker fund / index fund right? That will give you a low risk, low cost, highly diversified bet on the long term value of equities. Sure, you may want to drip-feed funds in, because it could fall another 20%.

We….ll, as ever, maybe it’s not that simple.

Industry sector weights in the ASX 100

For example, if you look at the broader Australian stockmarket, you find that actually were you to buy an ASX 100 tracker you are effectively taking a bet on two sectors in a big way, financials and mining. For instance Jun 2008 S&P sector weights show that the ASX 100 is 8.41% energy, 28.17% Financials-ex-Property, and 30.1% materials. In other words 64% of the large cap end of the index.

Industry sector weights in broader ASX indexes

So what about a broader tracker, for instance the State Street SPDRs tracker for the ASX 200?

Well this is actually a similar sector bet. For example Oct 2008 figures (i.e. even after the credit crisis fallout of the last 12 months) show a sector weight of 39% on financials, and 21% on materials, and 6% on energy, a total of 66%…

It is only when you get to the ASX Small Ordinaries (companies in the S&P ASX 300 but not in the S&P ASX 100) that financials drop to 7% but materials is still 31% and energy is still 14% taking the weight for the 3 to 51%.

You can not buy a tracker of the Small Ordinaries, you’d have to look at a managed fund like BT Microcap Opportunities or the equivalent, so in a sense this is rather academic, but it does give you a pointer to the extent that the Australian economy is dependent on these sectors, even after a commodity price fall and the banking price fall.

Sector weights in UK indexes

The FTSE 100 is 22% oil and gas, 21% financials, and 15% basic materials as of June 30 2008, another significant bet on mining and banking.

However the FTSE 250 is a significantly more diversified bet: 27% financials, 6% oil and gas, and 5.4% basic materials as of 30 June (probably significantly less of a financial and mining bet as of Oct 2008).

Non-standard ‘stylistic’ trackers can also give you some variation on the standard sectors. For example, the FTSE UK Dividend Plus tracker, which consists of the highest dividend yields in the FTSE 350 filtered by specific liquidity requirements, is 32% financials and 4% oil and gas as of 30 June.

Aren’t trackers about not guessing themes?

None of this is to say that we should be trying to guess what themes will do well (for instance a tracker that is heavily weighted to financials and diversified might not be a bad thing to buy at the moment).

It is also the case that not all trackers are equal. So-called ‘Enhanced Trackers’ where the managers have some freedom to track the index somewhat more loosely and use derivatives, supposedly often perform better over the longer term by anticipating index departures and arrivals, but more of that later.

Posted under index trackers, investment strategies

This post was written by mike on October 19, 2008

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1 Comment so far

  1. Trevor Tractor October 28, 2008 11:15 am

    That’s a very very good point.


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