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The FTSE isn't as strong as you think and you aren't doing as badly

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It’s been a pretty brutal twelve months for everyone investing in stock markets – not only here, but all around the world. But one area of optimism has been the performance of the UK broader benchmark – the FTSE All Share.

According to my measurement, the FTSE All Share has fallen by 6.2% over the last 12 months since October 4th. Given the index has yielded 2.77% over that timeframe, it’s been pretty robust in what have been very difficult markets.

But most of us are down 20%+ in this timeframe. Some subscribers have written in who have constructed their portfolios using 80+ ranked stocks and asked why the they are underperforming the FTSE so badly.

It’s a good question… but are we really underperforming?

Value Weighting vs Equal Weighting

One of the most vital things to get your head around when assessing an index’s performance is *how the positions are weighted*. This has a huge impact on the reported returns.

* Value Weighting – often called “market capitalisation weighting” – is weighting each position relative to the total value of the company’s shares (market capitalisation). In this way Shell (at £161bn market cap) will we weighted almost 12,000 times larger in the index versus Made.com (£13.7m market cap).
* Equal Weighting – this is the process of weighting each position in exactly the same size. So Shell and Made.com would have the same weights.

Most benchmark indexes use Value Weights (Market Cap Weights) for their construction. There are huge benefits to doing so as it’s so much cheaper for product providers (like Vanguard, iShares etc) to build investment products around them. In a value-weighted index fund, once a position is bought, it doesn’t need traded again. It’s buy and hold forever, or until a stock leaves the index. Equal weighting on the other hand requires regular rebalancing of position sizes, so is more expensive to operate.

The equal weighted performance of the FTSE All Share

One useful feature on the site is the ‘simulation charts’ that we provide on watchlists. These create an equal weighted portfolio of shares from all watchlist constituents 12 months ago and track the performance forwards. It provides a quick measure of the difference between equal and value weighting below.

I created one quickly by copying in all the FTSE All Share constituents. In the chart below you can see the official ‘value weighted’ FTSE all Share performance in grey, but the ‘equal weighted’ FTSE All Share performance in blue.

0cf58962b2a2651112712878bd93caf0022d73f01664811677.jpg

The equal weighted FTSE All Share has declined 23.3% in the last year, versus a value weighted decline of 6.2%.

Why such a difference?

Well the performance of a market cap weighted index is due to the handful of giant stocks that dominate it. Of the top 20 stocks by size in the FTSE All Share – 15 have risen in price in the last year, and only 5 have declined. The resilience of the index has been driven by the dominance of large cap, value stocks in the index. It’s been a great time for large cap value stocks.

But the average stock is down 23.3% in this index. If we looked at the FTSE AIM All Share, I’m sure we’d see the average stock down far, far more.

Comparing the StockRanks performance vs FTSE All Share

The StockRank performance histories that we provide in the Learn gt; StockRanks section are also based on equal weighted performance tracking, not value weighted. So we can compare the 80+ StockRank set of shares over the same 12 month period (using annual rebalancing) and see a similar story.

While the 80-100 ranked stocks have underperformed the value weighted index, they have actually outperformed the equal weighted FTSE All Share by about 2%.

34478f0053572ba4a348c5161bf56c0352b3c1ca1664811809.jpgKey takeaway

The performance of the FTSE has been driven by a handful of large cap value stocks – but the average stock has suffered a lot of pain. This is masked by the market cap weighting of the index.  If we unwrap the index as an equal weighted portfolio, it’s far more comparable with typical private investor portfolios.   The StockRanks have held up well against the equal weighted FTSE All Share – especially given they include AIM stocks which have been even harder hit than main list stocks.

Large cap value has been the very best strategy in the market in the last 12 months – and given the market predicament this may continue until there’s an intervention or the regime changes. I’ve long argued that every investor should keep some large cap value spine in their portfolio, but given most private investors equal weight their portfolios it’s unlikely many of us are seeing FTSE All Share type returns.

My expectation is that at some point we’ll see a bottom in these markets – when that happens I won’t predict, but the market itself will tell us. When markets bottom after a bear market, the stocks that recover fastest are almost always the beaten down small cap value stocks. That’s not to say these kinds of stocks have bottomed yet, but when they do, they will be the first to bounce back. In coming weeks we’ll publish some more articles about positioning a portfolio for a recovery.

Stockopedia


Source: https://www.stockopedia.com/content/the-ftse-isnt-as-strong-as-you-think-and-you-arent-doing-as-badly-954959/


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