The UK stock market is bigger than most and includes plenty of major global companies. It's inevitable that most UK private investors are going to put at least some of their money into UK stocks, and many will go for the large cap businesses in the FTSE 100 or 'Footsie.'

Active/passive

What's more, thanks to its size and liquidity, the UK market is particularly suitable for passive investing - especially the large cap stocks. Remember the Footsie is a widely followed index and there are thousands of people in the City who are closely analysing its constituents, and trading the shares frequently too.

That means share prices should, if you believe the theory, be pretty efficient. In other words, share prices should reflect all the information about a particular company at that moment. And passive investing works especially well in efficient markets.

Which index to go for?

We've already mentioned the FTSE 100 in this article, and it's much the best-known UK index, comprising the hundred largest companies on the London stock market. The companies with the biggest valuations or market caps comprise the largest parts of the index. In other words, the Footsie is a market-cap weighted index. However, there's also an adjustment for free floats - that's shares that are readily tradeable and not owned by other companies or insiders.

The FTSE 100's biggest plus point is that a majority of its shares are global businesses, so you're getting plenty of exposure to the global economy with the Footsie.

However, on the downside, that global exposure is far too concentrated into a few sectors and not many companies. More than half of the index by value is comprised of companies in just three sectors: financial services, consumer defensive and energy.

FTSE 100 by sector

Sector % of FTSE 100
Financial Services 21.7%
Consumer Defensive 18.5%
Energy 14.6%
Healthcare 9.6%
Basic Materials 9.3%
Source: Morningstar, August 2017

And there's a similar issue with individual companies:

Top ten FTSE 100 companies

Company % of FTSE 100
HSBC 7.83%
British American Tobacco 5.84%
Royal Dutch Shell 'A' 5.03%
BP 4.59%
Royal Dutch Shell 'B' 4.3%
GSK 3.73%
Diageo 3.18%
Vodafone 3.1%
AstraZeneca 2.73%
Unilever 2.73%
Source: BlackRock August 2017

So the top ten companies comprise 40% of the index. That's a lot. If you put all your money in a FTSE 100 ETF, you cannot say you have a diversified portfolio.

So one alternative is to go for the FTSE All-share index which adds a bunch of extra stocks to the FTSE 100. In total, there are more than 600 stocks in the FTSE All-share. However, because many of the additional 500 or so companies in the All-share are pretty small, the FTSE 100 still makes up most of the All-share index - around 80% by value. So the FTSE All-share still isn't very diverse even if it's a little more diverse than the FTSE 100.

It's also worth noting that the FTSE All-share doesn't include all the shares on the London market. There are more than a thousand tiddlers that aren't included.

Another option is the FTSE 250 index. This is made up of the 250 largest companies in the index after the FTSE 100. The nice point about the 250 is that many of its constituents are UK-focused businesses. So if you're optimistic about future prospects for the UK economy and want to invest in UK plc, it makes sense to put some money into the 250. We'll look at this index in more detail in a future article on UK mid and small-cap investing.

Then there's the MSCI UK index which is pretty similar to the Footsie. It currently comprises 109 stocks and accounts for around 85% of the UK stock market by value. It's a market-cap weighted index with some adjustments for free floats and liquidity. The attraction is that if you're investing in other markets by tracking MSCI indices, you may want to be consistent and use an MSCI index for your UK investments.

What the experts say

Peter Sleep, Senior Investment Manager at 7 Investment Management highlighted the fact that the Footsie 100 is 'deep and liquid.'

He also said that anyone who wanted to take a smart beta approach should consider investing in an 'equal weight' FTSE index. So in an equal weight FTSE100, all the constituents comprise 1% of the index's value. He said that it's relatively easy to understand and 'tends to outperform' even if it's 'a bit more volatile' than the conventional Footsie.

Featured ETFs

  1. Biggest UK ETF - ishares Core FTSE 100 UCITS GBP (LSE: ISF)
As the name suggests, this ETF tracks the Footsie and the fund size is £4.8 bn. The ongoing charge is low at 0.07%. If you want to track the Footsie, this is an attractive option. This ETF uses full physical replication - in other words, the ETF buys shares in all constituents of the index.
  1. Cheapest UK ETF - joint first place for three ETFs
There are three UK ETFs that charge 0.07% a year. We've already mentioned one - the ishares Core FTSE 100 UCITS GBP. The other two are the HSBC FTSE 100 ETF (LSE: HUKX) and the ishares FTSE 100 ETF (LSE: CUKX). All three ETFs use full physical replication.

It's worth noting that the absolute cheapest UK passive investments aren't ETFs. The ishares UK Equity Index fund has an ongoing charge of 0.06% a year. The fund is a unit trust which means it's not traded on the stock market and doesn't have a price that is changing all the time. Instead a price is set once a day.

Similarly, the Legal & General UK Index fund also has an 0.06% annual charge, but only if you buy it via the Hargreaves Lansdown platform.

  1. Biggest Smart Beta - the UBS MSCI UK IMI Socially Responsible UCITS ETF (LSE: UKSR)
This ETF tracks larger UK companies but excludes any businesses involved in nuclear power, tobacco, alcohol, gambling, military weapons and genetically modified organisms. The ETF tracks the MSCI UK IMI Extended SRI 5% Issuer index which caps any individual company at no more than 5% of the index. This should mean that the ETF is a bit less concentrated than would otherwise be the case.

The ongoing charge for the fund is 0.28%.

  1. Worth highlighting - db x-trackers FTSE 100 Equal Weighted UCITS ETF (LSE: XFEW)
This ETF follows the equal-weighting strategy highlighted by Peter Sleep. It invests in all members of the FTSE 100 but gives them an equal weighting. So HSBC comprises 1% of the fund as does Next and AstraZeneca. This ETF uses full physical replication.

The fund has an ongoing charge of 0.25% a year.

5. Worth highlighting - db-x trackers FTSE All Share UCITS ETF (LSE: XASX)

If you don't fancy tracking the FTSE 100, you can get a bit more diversification with the FTSE All Share. This is probably the best of the All-Share ETFs but it comes with a 0.2% charge, so a bit higher than the best FTSE 100 ETFs. This ETF uses 'optimised sampling' which means it buys shares in many of the companies in the All Share index but not every single one.