The FT fund had a good first quarter, generating a return of 7.5 per cent, with more gains since. Reviewing why tells us a lot about these markets. The returns remain very concentrated, with much of the gain from the new economy, as represented in the main US and Chinese indices.
The fund’s big winning holding in recent years has been the position in Nasdaq. Just as US digital companies have led the western world in winning revenues and making profits, so Nasdaq has led the world’s stock markets up. The Nasdaq holding shows a 140 per cent gain since originally purchased.
The decision to buy back into China around the turn of the year also worked well. The Chinese digital giants are strongly represented in the Chinese index, and this has taken off in 2019 on hopes of an economic recovery in the country and expectations of more economic stimulus. The holding is up 30 per cent as I write.
Index investing has several advantages. It keeps costs down compared with active funds. It avoids the need for expensive detailed analysis company by company, and avoids getting individual company decisions wrong. Indices like the S&P 500 or the Euro Stoxx 50 limit themselves to the biggest companies, as their names imply. An index sells or removes poor performing companies and substitutes better performing companies on a regular basis with an iron discipline.
An index runs its successes, so you hold more value in the winning companies, and less in the losers. When an active manager is tempted to take profits, the index holds on. Academic research shows us that much of the extra value holding shares can bring comes from holding just a few big time winners.
The average or below-average stock on the market does not perform that well and may fall out of the index after a spell of poor performance. A limited list index ensures you remain invested in the premier league companies and avoid the second division. Alternatively, you can choose an index that concentrates on smaller companies on the way up, which can also do well if the criteria for selection are well adapted. Even a general index has a high weighting in the most successful large companies.
This most unloved of all bull markets has enjoyed a new lease of life. The excessive pessimism of December, when many commentators feared recession from an ever tightening money policy in the US, China and the euro area, was banished by the US Federal Reserve and the Chinese authorities pointing to changes of policy to relax the squeeze.
As I hoped, they did enough to reassure share markets and to justify taking the fund to the maximum permitted in shares for its risk rating. They encouraged sovereign bond markets to bid up the price of many of the government bonds to cut interest rates.
Some now worry that these very low interest rates imply bond investors expect a recession, while higher share prices seem to indicate a continuing recovery. This need not be a contradiction. Both markets are suggesting interest rates have to stay lower for longer, or even fall, so that economies can expand modestly. No one thinks inflation is a major problem in the advanced world, allowing central banks to be more relaxed about interest rates and credit growth.
There is a general manufacturing downturn, with a recession in the car sector. This has hurt Germany in particular. The German economy fell in the third quarter of 2018, went sideways in the fourth quarter, and is still struggling with falling demand for cars in 2019.
Italy remains in recession and the rest of the eurozone is slowing. China has been hit by a drop in domestic demand for cars, and by a general fall in export orders for a wide range of manufactured products. Some of this comes from the Trump tariff war, but much of it just reflects a world with slowing money growth and fewer new car and home loans. People with money often already have enough manufactured goods. They want to spend more of their cash on leisure, entertainment and digital devices and services.
Active stock pickers have to do a lot of work to see which companies can adapt to the digital age and exploit the new technologies for their own benefit. The danger is a well-established company using traditional business approaches is stuck with the need to make a large investment in new ways of doing things to compete against itself.
A traditional retailer has to pay the staff and property bills for all its shops, while spending on an online presence to match the digital challengers at the same time. The carmaker that invested a fortune in producing new clean diesels now has to invest again in a new generation of electric vehicles, with the double costs of diesel and electric against the new competitor just offering electric.
Some of the great brands of the past will succeed with this transition. Others will be overwhelmed by the business challenge and the costs of change.
In the latest burst of enthusiasm for technology, some investors will pay too much for technology companies with ambitions bigger than their management skills. Not all technology companies will survive and not all will live up to their racy first listing prices. The FT fund shows that so far trusting the index to sort it all out has worked well, with the Nasdaq investment and the other specialist indices in technology leading the gains for the fund. But the higher the market rises, the more cautious I am about the share outlook.
Sir John Redwood is chief global strategist for Charles Stanley. The FT Fund is a dummy portfolio intended to demonstrate how investors can use a wide range of ETFs to gain exposure to global stock markets while keeping down the costs of investing. email@example.com