Parenting Food Strikes and Investment Diversification
Right now, I’m navigating a particularly challenging phase of parenting—what some might call a “food strike” with my toddler.
Foods that once won him over, like spaghetti hoops and peanut butter toast, have suddenly fallen out of favor. Even peas, which he used to love, are off the menu today if he’s not in the mood.
This situation leads to his worries about going to bed without food and waking up hungry. So, each evening, I offer him a variety of appealing dishes, hoping that something will be satisfactory.
This method is a bit like the investing principle of diversification. The idea is that by spreading investments across various asset classes and regions, one can better withstand economic fluctuations. No matter how chaotic the market gets, it’s good to have something that appeals to the market in your portfolio.
Many investors recognize the value of diversification and are increasingly opting for tracker funds—these are low-cost funds that aim to match indexes, like the well-known FTSE 100 in the UK. But the real question is: just how diverse are these funds?
There’s a risk of concentration, where too much investment is tied up in a limited number of assets, countering the benefits of diversification. In the case of tracker funds, this risk tends to arise from how investment is allocated among a few large companies featured in the index.
A bit of concentration is expected, especially in sector-specific or thematic investments, yet recent analysis from AJ Bell reveals that even standard tracker funds can have a significant investment in a narrow range of stocks.
AJ Bell’s Laith Khalaf examined funds with assets exceeding £500 million in key sectors, finding that one tracker fund allocated nearly 58 percent of its assets to just ten stocks. In practical terms, for every £1 invested, 58 pence goes to those ten companies.
“Investors who choose specialized funds are usually targeting specific risks and returns. However, we are noticing elevated concentration levels even in typical tracker funds, which may be surprising to some,” Khalaf mentioned.
The L&G Global 100 Index, which tracks major multinational companies, exhibited the highest concentration risk, with 57.6 percent of its assets tied up in the ten largest firms.
Other notable funds include Halifax’s FTSE 100 fund, with 46.4 percent of its assets in the top 10 stocks, and Vanguard’s FTSE UK Equity Income and L&G’s UK 100 funds, both hovering around 46.1 percent in the same category.
Investing in trackers with high concentration risk isn’t inherently negative, but relying on a fund that tracks a broad index with numerous companies might create a false sense of security regarding your portfolio’s diversification.
Take the Vanguard Global Stock Index Fund, for instance—though it tracks over 1,300 stocks in the MSCI World Index, it still invests 26.2 percent in just the top ten companies.
When assessing concentration risk, it’s also wise to consider the index being tracked. For instance, funds following the FTSE 100 exhibit high concentration risk, yet the FTSE 100 is diversified across various sectors. The largest companies include AstraZeneca, HSBC, Shell, Unilever, and Rolls-Royce, which means the bulk of investments spans healthcare, finance, energy, consumer staples, and industrial sectors.
On the flip side, the S&P 500, representing top U.S. firms, features four out of five companies as tech stocks, with the fifth—Amazon—also heavily linked to technology through its cloud computing services.
To gauge your diversification, use tools available on your investment platform. Most platforms will allow you to see how your investments are distributed across regions and sectors. If a particular fund raises concerns, checking its fact sheet could be beneficial.
As with any investment, it’s essential to align your risk exposure with your personal comfort level. If you prefer, you might allocate 80 percent of your portfolio to one focused fund. Ultimately, it’s crucial to understand the risk level and whether it aligns with your investment goals.
In simpler terms, make sure your eggs aren’t all placed in the same basket. By the way, eggs have also made it onto our little one’s list of least liked foods.
