Five top UK ETFs

by , 23rd August 2018

UK shares are relatively cheap at the moment. If you want to take advantage, ETFs can be an easy way to get exposure to the UK market. So in this article, I’m going to highlight five UK ETFs that might appeal.

But before we do that, let’s look at how cheap the UK market is.

PE and CAPE ratios

One way to measure value is the widely-used price/earnings ratio (P/E). This ratio compares share prices and profits.

Looking at this table, the UK’s stock market doesn’t look especially cheap.

Country P/E ratio
India 26.2
United States 21.4
Brazil 18.4
United Kingdom 17.1
France 17.1
Germany 14.8
Japan 14.5
China 7.4

Source: Star Capital, 31-07-2018

But if you use the CAPE ratio (cyclically adjusted price/earnings ratio), you get a different picture. The CAPE ratio compares average profits over a period of ten years with share prices, and probably gives a more accurate picture of a company or market’s value.

The UK has a relatively low CAPE ratio – it’s on a much lower multiple than the US or Japan.

Global CAPE ratios (cyclically adjusted price/earnings ratios)

Country CAPE ratio
United States 31.2
Japan 27.2
India 23.6
France 21.6
Germany 20.1
United Kingdom 16.9
China 16.8
Brazil 13.4

 Source: Star Capital

Personally, I think the CAPE ratio is more powerful than the conventional p/e ratio, so there’s at least a case for investing in UK shares.

Why is the UK cheap?

Brexit is part of it. Concern about Brexit’s impact on the UK economy is understandable, but you should remember that many London-listed companies are global businesses that generate a large proportion of their profits away from the UK.

The other issue is that the UK market is heavily slanted towards a small number of sectors – in particular, resources, finance, pharmaceuticals and consumer stocks. Until this year, oil and mining stocks have been held back by low prices whilst banks still haven’t fully recovered from the 2008 crisis.

This concentration in just a few sectors means that investing purely in the UK market is almost certainly a mistake. But given where we’re at with the CAPE ratio, there’s clearly a case for investing some of your assets in UK shares.

So let’s look at those five UK ETFs:

  1. iShares Core FTSE 100 UCITS ETF (ISF)

This is a massive fund, with a fund size of £5.9 billion, giving cheap exposure to the flagship FTSE 100 index.

The annual charge is 0.07% which means you’ll only pay 70p a year on an investment worth £1000. Admittedly, this isn’t the very cheapest UK ETF – that honour goes to the Lyxor Core Morningstar UK UCITS ETF (LCUK), which has an annual charge of 0.04%. However, going for the Lyxor ETF would only save you 30p a year on a £1000 investment. What’s more, the Lyxor ETF is still pretty small with only £10 million under management. The size difference means the iShares ETF should be more liquid and have a tighter bid/offer spread.

Here are some performance figures:

Period Year to date 1 year  

3 years

(annualised)

 

5 years

(annualised)

Total Return 1.5% 7.8% 10.2% 7.1%

 

The composition of the ETF is much as you’d expect for a FTSE 100 tracker:

Stock % of ETF Sector % of ETF
HSBC 7.0 Financial Services 19.3
Shell ‘A’ 5.7 Consumer Defensive 17.8
BP 5.4 Energy 16.5
British American Tobacco 4.8 Healthcare 10.8
Shell ‘B’ 4.7 Consumer Cyclical 9.9

Source: Morningstar 17-08-2018

  1. SPDR FTSE UK All-Share UCITS ETF (FTAL)

If you’re worried that the iShares Core FTSE 100 ETF isn’t sufficiently diversified, this SPDR ETF is a bit better. It tracks the FTSE All-Share index which comprises around 640 stocks, many more than the FTSE 100. However, the extra diversification isn’t as great as you might think. That’s because the FTSE 100 comprises more than 80% of the All-Share by value.

The extra diversification also comes at a cost, albeit small, with an ongoing charge of 0.2% a year rather than 0.07% for the iShares ETF. The fund size is £515 million.

Here are some performance figures:

Period Year to date 1 year  

3 years

(annualised)

 

5 years

(annualised)

Total Return 1.4% 7.3% 9.9% 7.7%

Here are the top 5 constituents and sectors in the ETF:

Stock % of ETF Sector % of ETF
HSBC 5.9 Financial Services 19.4
Shell ‘A’ 4.8 Consumer Defensive 15.2
BP 4.5 Energy 14.7
Shell ‘B’ 4.0 Consumer Cyclical 11.1
British American Tobacco 3.8 Industrials 9.6

Source: Morningstar 31-07-2018

  1. Vanguard FTSE 250 UCITS ETF (UMID)

Another way to diversify is to invest in this Vanguard ETF. It tracks the mid-cap FTSE 250 index. This index comprises the 250 largest companies on the London market excluding the FTSE 100. Traditionally the 250 index is perceived as comprising more UK-focused companies than the FTSE 100, but the reality is the FTSE 250 is more of a global investment than you might think. Still, you are investing in a different bunch of companies than those in the FTSE 100.

The ongoing charge is 0.1% a year and the fund size is £757 million.

Interestingly, the performance figures for this Vanguard ETF aren’t that different from the two ETFs we previously looked at:

Period Year to date 1 year  

3 years

(annualised)

 

5 years

(annualised)

Total Return 1.4% 7.6% 9.5%

Here are the top 5 constituents and sectors in the ETF:

Stock % of ETF Sector % of ETF
Spirax-Sarco 1.3 Industrials 23.6
Weir 1.2 Financial services 18.6
Hiscox 1.1 Consumer Cyclical 17.0
Meggitt 1.1 Real estate 8.9
Wood Group (John) 1.1 Technology 7.0

You can see there is a significant difference to your exposure compared to the FTSE 100.

  1. Db x-trackers FTSE 100 Equal Weighted UCITS ETF (XFEW)

This ETF tracks the FTSE 100 Semi Annual Equally Weighted Index. It comprises all the companies in the FTSE 100 but the big difference is that each company comprises 1% of the index by value. The companies are equally weighted. As share prices move around, the index is rebalanced every six months – in other words, the holdings are brought back to 1% for each company.

Fans of ‘equal weighting’ argue that it should deliver better results than conventional ‘plain vanilla’ index tracking. That’s because if you invest in a conventional FTSE 100 tracker, you end up becoming more exposed to the biggest shares as their share price rises. You may become over-exposed to an over-valued giant at the top of the index – Vodafone at the height of the internet boom in 2000 is a good example of this. But with equal weighting, every time the index is rebalanced, you’re buying shares in the companies in the index that have fallen in price.

The ongoing charge is 0.25% and fund size is small at £24 million.

Period Year to date 1 year  

3 years

(annualised)

 

5 years

(annualised)

Total Return 4.1% 7.1% 9.7%

US data suggests that equal-weighting does outperform over the longer term. The data in the above table shows strong out-performance by this ETF in 2018, but less so over the last one or three years.

It’s pointless showing a table with the top 5 constituents – all shares are at 1% – but it’s interesting to look at the top sectors:

Sector % of ETF
Consumer Cyclical 22.4
Financial Services 15.9
Industrials 13.4%
Consumer Defensive 13.1
Basic Materials 11.3

Source: Morningstar

  1. Invesco FTSE RAFI UK 100 (PSRU)

This is a ‘smart beta’ ETF. In other words, it tracks an index constructed to implement a particular investment strategy. The index is FTSE RAFI UK 100 index which is operated by the US research firm, Research Affiliates, and FTSE. Research Affiliates was founded by Rob Arnott, a leading theorist in the smart beta world. The index assigns weightings to firms in the FTSE 100 index by using a formula that looks at dividends, free cash flow, total sales, and book value.

The fund is tiny with a size just under £10 million. It’s also relatively expensive for a UK ETF with an ongoing charge of 0.39% a year. However, the performance over the last five years has been pretty good and has beaten a conventional FTSE 100 tracker.

Period Year to date 1 year  

3 years

(annualised)

 

5 years

(annualised)

Total Return 2.1% 9.2% 12.8% 7.5%

 

Stock % of ETF Sector % of ETF
BP 9.8 Financial services 23.1
HSBC 8.3 Energy 20.1
Shell ‘A’ 5.3 Basic Materials 9.2
Shell ‘B’ 4.5 Healthcare 8.4
Vodafone 4.0 Consumer Cyclical 8.0

Source: Morningstar

So that’s five ETFs that might help you invest in the UK stock market. Just make sure that you diversify by investing in non-UK markets as well.

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