I would argue that the lower reaches of the FTSE 100 offer better investment potential than the 30 or so largest firms in the index.
It’s tempting to go for a FTSE 100 tracker fund to try to capture upside potential in the index while at the same time achieving diversification. However, a basic FTSE 100 tracker fund allocates around 70% of our invested funds to the largest 30 firms because of allocation by weighting — the biggest firms end up with more of our money than the smaller ones do.
In effect, a weighted FTSE 100 tracker keeps most of our investment out of the companies with the greatest potential. The solution, to me, is individual stock-picking, and I think smaller firms such as Schroders (LSE: SDR) can outpace giants like HSBC Holdings (LSE: HSBA).
Big problems
The big banks have many well-documented on-going problems. In the case of HSBC, regulatory headwinds combine with lacklustre growth in the firm’s international markets to produce flat business progress. Is there a big bank around today that isn’t involved in major restructuring and navel-gazing as once profitable lines of business dry up and directors rethink operational business models?
Right now, I see the big banks as risky. Profits are high, having recovered from cyclical lows following the financial crisis. Low price-to-earnings ratings and high dividend yields look like more of a warning than an attraction. When valuations are low after a period of strong profits, the banks are dangerous reckons legendary one-time Fidelity fund manager Peter Lynch.
The big banks are among the most cyclical beasts on the stock market and when profits are up, as now, I reckon the path of least resistance is down — for profits and for the share price. In the meantime, valuation-compression seems set to keep investor total returns in check as the market tries to discount rising profits in an effort to anticipate the next collapse.
A focused business model
Rather than risk an investment in HSBC, I think family-controlled fund manager Schroders looks like a better bet in the financial sector. The firm’s over-200-year heritage inspires confidence and the constant arrival of fee income has driven a good performance on total returns in recent years. It’s interesting to compare how investors have fared with Schroders and HSBC.
|
Company |
Share price 1/1/12 |
Share price 14/6/16 |
gain/loss |
Dividends |
Total return pence |
Total return percent |
|
Schroders |
1,300p |
2,422p |
1,122p |
292p |
1,414p |
109% |
|
HSBC |
487p |
426p |
(61p) |
148p |
87p |
18% |
It’s true that past performance of an investment is no reliable guide to its performance in the future because investments can go down as well as up, but a good track record tells us something about a company’s form, in my opinion.
At today’s 2,422p share price Schroders trades on a forward P/E rating of just over 13 for 2017 and pays a dividend yielding around 3.9%. That’s a comfortable valuation for a firm that has proved its growth credentials.
An economic slowdown will likely weaken Schroder’s shares if it comes, but the firm’s focused business model — fund management — should leave the company less vulnerable than an out-and-out cyclical firm with a complex and geared business model such as HSBC.
