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THE TIMES (UK): You could be off the scent with trackers: INVESTMENT: “RISING oil prices and the company restructuring at Shell mean that just two shares — BP and Shell — will make up nearly 20 per cent of the FTSE 100 index next year…" ( 20 Nov 04


By Mark Atherton

November 20, 2004


RISING oil prices and the company restructuring at Shell mean that just two shares — BP and Shell — will make up nearly 20 per cent of the FTSE 100 index next year, leading to renewed questioning of the old idea that tracker funds, widely held in Peps and Isas, are a low-risk way to gain exposure to the stock market.


Critics of trackers, which replicate an index such as the FTSE 100, argue that a fund with a fifth of its money in just two shares is far from a steady, middle-of-the-road investment.


The recent bout of restructuring at Shell will result in both parts of the Anglo-Dutch company being listed in combined form on the London Stock Exchange. This will, at a stroke, increase the share of the FTSE 100 represented by the oil company from 3.6 per cent to 8.6 per cent.


Not only does this mean that index funds will have to plunge into the market to top up their Shell holdings to the required percentage, it also means that they have to sell other holdings to reflect their reduced weightings.


Jason Hollands, of F&C Asset Management, says: “The current strength of oil company shares serves to highlight the way that index funds are heavily skewed towards certain sectors. They are dominated by oils, banks, telecoms and pharmaceuticals, so buying a tracker does not give broad exposure to the market or diversify risk — it concentrates it.


“The top ten companies in the FTSE 100 will make up about 55 per cent of its value. So if those ten don’t perform, the tracker won’t perform.”


Much the same principle applies to the wider FTSE all-share index. It, too, is dominated by Shell and BP, which will make up 15 per cent of the index, while the top ten stocks will account for 45 per cent. At the end of 1985, the ten biggest stocks represented just 27.3 per cent of the index.


Mr Hollands says: “This demonstrates how illusory the perceived diversification of indexation has become. We are not against trackers — we run a low-cost tracker — but we think people should understand the risks attached.”


But the impact of Shell and BP’s dominance of the stock market goes beyond tracker funds, which make up an estimated 12 per cent of all fund money. Billions of pounds are invested in so-called closet trackers, which follow the index so closely that they are trackers in all but name. These closet trackers will also have to shuffle their holdings to reflect the new weightings.


Furthermore, many genuine active funds have the FTSE 100 or all-share index as their benchmark. Mr Hollands asks: “If fund managers are to take genuine active bets by buying companies they like, shouldn’t their performance be assessed on the basis of absolute return — that is making money not losing it — rather than against an increasingly skewed index?”


John Hatherly, of M&G, the investment manager, agrees. “We offer two tracker funds, but there is no doubt that the popularity of absolute-return funds has been growing. One reason is the inability of the indices to capture significant movements within the stock market. The FTSE 100 and all-share indices are up about 6 per cent in the year to date. But this rise masks huge variations in different sectors. The real excitement has lain beneath the surface of the index, where successful operators have picked the best-performing sectors and stocks.”


Top notes


Two oil stocks — Shell and BP — will next year make up nearly one fifth of the FTSE 100 index.


The top ten companies in the FTSE 100 will account for about 55 per cent of the index’s value.


Private investors hold more than £10 billion in tracker funds, much of it in Peps and Isas.


The biggest tracker funds are L&G’s £2.8 billion UK Index fund and Virgin’s £1.7 billion UK Index Tracking fund. A sum of £1,000 invested in the L&G tracker ten years ago would now be worth £1,849.

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