Why I’m sticking with my passive Isa strategy
Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The seemingly unstoppable might of the “Magnificent Seven” means these are exciting times to be a passive investor. But as someone who uses her stocks and shares Isa predominantly to invest in low-cost global tracker funds, “exciting” wasn’t what I thought I had signed up for.
The valuations of those seven US tech-focused giants — Microsoft, Nvidia, Apple, Amazon, Google parent Alphabet, Meta and Tesla — have collectively soared nearly 20 per cent since the start of the year on hopes that AI will turbocharge their future growth prospects. Of these, Tesla is the least magnificent, down 30 per cent year-to-date, but Nvidia is up by an eye-popping 83 per cent.
How this translates to your own portfolio’s performance depends on the precise type of passive fund you have, but the dominance of the Mag 7 means they are making up a growing slice of global index tracking funds.
Should this worry us? On one hand, it’s hard not to be pleased when your tax-free investment shows a healthy performance gain. But the rising concentration risk has made me question whether I should continue with a predominantly passive strategy in the coming tax year.
“Boring is good” is the investment mantra that I have recited in this column many times before. Like many passive enthusiasts, I don’t try to beat the market, but regularly buy a slice of the market. Yes, I could try chasing higher returns by investing most of my money in actively managed funds, or have a stab at stock picking myself, but countless studies show that the long-term effect of consistently (and cheaply) achieving an average return almost always produces a better result for considerably less effort. For the cash-rich but time-poor investor, this last point is also key.
But should I tweak the passive funds I’m investing in to add greater diversification? This Isa season, you might be pondering the same dilemma.
A good place to start is looking under the bonnet of the different passive funds you may hold, and deciding whether you’re happy with these weightings.
Funds that track US indices will have a much higher exposure to the Mag 7 (currently about 30 per cent for the S&P 500 or as much as 40 per cent for the Nasdaq).
Most global equity trackers dial this down to below 20 per cent, as shown by the chart of the MSCI All-Country World Index below.
However, over time, the top 10 stocks have made up a growing proportion (the Magnificent Seven are all in there — although Alphabet is counted twice due to having two share classes, plus US pharma giant Eli Lilly and chipmaker Broadcom).
“Although this level of concentration risk is more than recent history, when we look at the long-term history of investing, it’s nothing new,” says James Norton, head of financial planners at Vanguard, noting past vogues for financials, energy and materials and transportation sectors.
Geographically speaking, the US market is not an outlier. The top 10 stocks make up around 30 per cent of the MSCI USA index, but this rises to just over 40 per cent for the MSCI China Index; over 48 per cent for the MSCI UK Index; and over 58 per cent for both Germany and France (note that some of these indices have far fewer constituents than others).
You may also be more diversified than you realise. In Vanguard’s FTSE Global All Cap Index Fund (which I hold within my own Isa), the UK exposure is below 4 per cent, with the US making up nearly 62 per cent.
Yet Vanguard’s popular LifeStrategy funds range (which also feature within my own Isa) have an inbuilt bias towards the UK, which accounts for 25 per cent of the equity component. The rest is allocated on a market cap weighted basis (as of last week, the US accounted for around 36 per cent).
I’ve spread my bets. I’m happy to have some home bias in one of my portfolio “building blocks” as I think the UK is too cheap, and I can afford to take a long-term view, though I appreciate many readers may not share my optimism. But it also illustrates the dangers of letting an active mindset influence a passive strategy!
Investors could also look at increasing their exposure to passive funds tracking European or emerging market indices, or diversify away from equities by considering multi-asset funds.
But there is also a risk that you will be giving away growth.
Norton doesn’t dispute that US equity valuations are punchy, but adds: “That doesn’t mean they can’t get punchier.”
Ultimately, it comes back to your investment timeframe and wider investment goals. What are you investing for?
I view my own stocks and shares Isa as a flexible retirement fund which I’m hoping to leave invested for decades to come. However, if I were closer to retirement age and more risk averse, I might be more tempted to take some profit and diversify further, or even transfer some funds to a cash Isa (don’t forget, Isas don’t have the inheritance tax advantages of pensions — you will need to spend the money).
If this is a strategy you’re considering, Laith Khalaf, head of investment analysis at AJ Bell, urges investors to consider doing so gradually. “By recycling cash into a new area bit by bit, you’re getting the average price over a period rather than taking the risk of putting a large amount in or out at one point in time,” he says.
But if you’re going to stick with global index fund investing, a further supportive element is the huge volume of money being allocated to passive investments, which is helping to support mega cap share prices. However, Khalaf notes this is another factor working against the UK, which makes up just 4 per cent of the MSCI global index compared with around 10 per cent a decade ago.
Funnily enough, it was a recent conversation with an active manager on the Money Clinic podcast that affirmed my passive instincts. Ben Rogoff, fund manager of the tech-focused Polar Capital Trust, is not convinced that all seven “Magnificents” can stay on the right side of the AI trade for much longer, and is positioning his portfolio accordingly.
I wish him luck! But while he may have had the foresight to buy into Nvidia more than a decade ago, by choosing to adopt a passive strategy I’ve let the market do it for me, gaining exposure without even having to think about it. And in decades to come, when these seven stocks have become more or less magnificent, the same goes for whatever comes along to replace them.
Claer Barrett is the FT’s consumer editor and author of the FT’s Sort Your Financial Life Out newsletter series; claer.barrett@ft.com; Instagram and TikTok @ClaerB.
To watch a recording of the FT’s free Isas and tax-free investing webinar featuring Claer Barrett, Moira O’Neill and Timi Merriman-Johnson, click here.
Comments