Jenny asks: “I hold £10k of Vanguard FTSE 100 ETF shares (VUKE) and I am buying about £100/month worth and reinvesting the dividends. Am I overexposed to the UK markets? Do I need to diversify my investments?”
Q&A 35 – Am I Overexposed In My Investments? – Shownotes
Today’s question comes from Jenny:
I hold about £10k of Vanguard FTSE 100 ETF shares (VUKE) and I am buying about £100/month worth and reinvesting the dividends.
I’m young and happy to have this money in stocks and shares currently, but I guess I’m a little overexposed to the UK with this ETF. I feel like VUKE gives me pretty good diversity considering the FTSE 100 is made up of mining companies, banks and other sectors, but I guess it’s probably too focused on the UK.
Does anyone have advice for diversifying my “portfolio”? I’d prefer to stick to low fee ETFs, so I guess that means Vanguard only.
Also, if I do need to diversify, should I just start buying a new type of share or should I sell off some of my existing ones?
Thanks in advance!
Thanks for your question Jenny and that’s a very good question.
A Great Start To Your Investing Journey
Well done for getting on your investing journey and starting with a low-fee market tracking ETF like VUKE is a good start. Even more impressively, you are very much asking the right questions here.
Your investment in VUKE effectively means that you have all of your investments in the top 100 shares on the London stock exchange in proportion to their size.
Whilst this makes it sound like you should be diversified, there are many areas where you still are not, and they are not all country specific as you allude to in your question.
The FTSE 100 ISN’T Solely UK-centric…
Whilst these 100 companies are listed on the London Stock Exchange, it doesn’t mean that their success is only linked of the success of the UK economy, or even the success of these companies in the UK.
As at the time of recording, over three quarters of revenues generated by the FTSE 100 companies is generated overseas. So, geographically, you may be better diversified than you think.
The key under diversification actually comes in two other areas.
…But Is Under Diversified!
The first of these is a lack of diversification against company risk. The total market capitalisation of the FTSE 100 companies is £1.7bn. The top twenty of these companies make up over £1bn of this, and the top five companies alone make up £400m or almost 25% of the whole FTSE 100.
So, whilst you make think that you are diversified across 100 different companies, in reality, 25% of your investment is with Royal Dutch Shell, HSBC, British American Tobacco, BP and GlaxoSmithKline.
This leads us to the second issue with under diversification related to sector risk.
Looking down the list, you can easily identify that the following very specific sectors make up very large chunks of the FTSE 100:
- Banks – 13%
- Household Goods – 13%
- Oil & Gas – 12%
- Healthcare – 10%
From this, we can see that very close to half of your investment is in just four sectors (out of 20 unique sectors in the market).
So, by only being in VUKE and tracking the FTSE 100 you are probably under diversified. However, this isn’t your only problems.
Because the FTSE 100 follows the largest 100 companies, these are considered to be generally lower risk and subsequently lower reward.
If we look at historical data from Yahoo! Finance, we can see that since records were held for the FTSE 100 and FTSE 250 (the next biggest 250 companies on the London stock exchange), the results have been significantly different.
The FTSE 250 has increased by 8.6% per year (excluding dividends), whereas the FTSE 100 has only increased at 5.0% per year (excluding dividends).
So, if you only hold VUKE, you are under diversified from a company, sector and probably from a country standpoint.
So, What Are Your Options?
Well, Vanguard, who you currently use for your FTSE 100 ETF investing also offer a range of other low-fee market tracking ETFs from around the world. The best of these from a diversification standpoint is probably VWRL – the vanguard All-World ETF. Looking at the fact sheet, which is attached in the show notes, we can see that this ETF:
- measures the market performance of large- and mid-capitalisation stocks of companies located around the world.
- Includes approximately 2,900 holdings in nearly 47 countries, including both developed and emerging markets.
- covers more than 90% of the global investable market capitalisation.
The ongoing charges are higher than the FTSE 100 index at 0.25%, but this may be a reasonable fee to pay to obtain instant diversification across your portfolio.
Some interest points to note about VWRL:
- 4% of the funds’ companies are based in the US, followed by 9% in Japan and 7% in the UK. However, remember that the US companies (as with the UK companies) will derive much of their revenues from overseas.
- The three largest single company in the FTSE 100 ETF were Royal Dutch Shell (6.0%), HSBC (5.8%) and British American Tobacco (4.0%). In VWRL, these percentages for the top 3 are much smaller with Apple (1.8%), Google (1.0%) and Exxon Mobile (0.9%) making up the top three.
- 5% is invested in the “financials” sector – this is about the same as the FTSE 100 ETF.
Am I Overexposed In My Investments? – Conclusion
So, to conclude, well done for taking the passive line of investing by investing in low-fee market tracking ETFs. However, with 100% of your investments in the FTSE 100 VUKE ETF, you are probably under diversified from a company, sector and geographical standpoint and you can mitigate this risk by putting future investments in other ETFs tracking more global indices.
Note that I wouldn’t recommend that you take any of your £10k that you already have in VUKE out because the impact of the buying/selling fees would negate the benefit you’d have by improving your diversification. Instead, just redirect the new money going into new investments.
So, quite an advanced investing question there. On Friday, we’ll be back with a slightly simpler question on your rights when a payment has been made to you in error: a question straight off the monopoly board. See you then!
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