Managing Your Money 

Are index trackers unsound?

James Norrington

James Norrington
Are index trackers unsound?

I am always a little suspicious of the advice to buy index trackers, the FTSE 100 in particular. Here we have an index based on the 100 companies with the highest capitalisation. One would never structure a portfolio in such an unbalanced manner.

Secondly an index that has its failures relegated and replaced by promoting the best-performing shares from the second division, must of necessity record an unreal outperformance, which is misleading, particularly as the index has, apart from oscillations, gained nothing in the past 20 years. There should be an index that is more representative of the proportions of a normal portfolio. Perhaps the top 350 shares equally weighted?

I use a homemade index that started at 50000 and each week I add the number of shares that rise and subtract the number of shares that fall. It has shown a decline over 10 years of 40 per cent, but as it includes Alternative Investment Market (Aim) shares, many of which are transient, this is to be expected. However it is useful to use it to confirm the direction of the popular indices. Many times it has fallen when the main indices are rising, which to me means that the probability of successful stockpicking during these apparent bullish periods is not good.

I conclude that basing one’s decisions on the movement in value of a few very large companies is unsound.

Julian Wade

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