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The Observer: Why you need to be sure about Shell: “This year, the oil company Royal Dutch Shell will become a completely British company, incorporated here, rather than a dual-listed operation split 60-40 between the Netherlands and Britain.” ( 9 Jan 05


Heather Connon

Sunday January 9, 2005


Do you think the price of oil will stay above $40 a barrel or drop below $20? Do you expect oil companies to continue to gush out profits and cash over the next few years?

You may not think these questions have much to do with your investment portfolio, but if you hold a fund that invests in large British company shares they are about to become key to its performance.


This year, the oil company Royal Dutch Shell will become a completely British company, incorporated here, rather than a dual-listed operation split 60-40 between the Netherlands and Britain. When that happens, the £60 billion or so of its value attributable to the Dutch side will be added to the £40bn of its British arm, making a company worth more than £100bn. It will then vie with rival BP, whose market capitalisation is similar, to be the biggest company on the London Stock Exchange.


Combined, the two oil giants will be a formidable force in the market, accounting for just under a fifth of the FTSE 100 and about 17 per cent of the All-Share index.


While the oil industry is clearly influenced by the things that affect share prices generally, such as the state of the economy and investor sentiment, the oil price is at least as important, as the jump in shares as oil soared last spring shows.


While most forecasters are predicting that the price will stay around current levels rather than falling back below $20, a year ago no one was predicting more than $50 a barrel. If the oil price does continue to fall this year, BP and Shell are likely to fall with it. The rest of the FTSE 100 will, therefore, have to make some impressive gains to keep the index moving ahead.


But oil is not the only industry dominating the FTSE 100; banks account for about a quarter of the FTSE and five of the top 10 companies. That underlines the increased concentration of the stock market, with a few global giants accounting for a sizable chunk of the index: the top five companies alone represent more than 36 per cent, the top 10 are more than half the FTSE.


Tim Cockerill, head of research at Rowan and Co Capital Management, thinks that such concentration makes life dangerous for the funds that track the index, whether the FTSE 100 or the All-Share (of which the Footsie accounts for 85 per cent of its total value).


To reflect the changed balance of the index, they will have to add to their holdings of Shell when it moves here in the summer, regardless of what they think of prospects for the oil price. And they will be much more vulnerable to any unexpected shocks from either company, as happened when Shell revealed the reserves overstatement which prompted the current restructuring.


Many so-called active funds are also closet trackers, which means that they stick very closely to the index to reduce the risk of underperformance.


So, many of the large generalist funds will also be scrambling to increase their exposure to Shell, thinking that they are playing safe. In fact, they will be taking bigger risks. Cockerill points out that even in very aggressive funds such as DWS UK Opportunities, which has just 26 stocks in its portfolio, the top 10 account for just over 40 per cent of the portfolio.


Neither does 'playing safe' produce good performance: over the year to mid-December, the best tracking fund came 43rd in the UK all-companies sector, with an increase of 18 per cent. But it was tracking the FTSE 250 mid-cap index, which is much less concentrated than the FTSE 100, and also lagged Schroder's UK Mid Cap fund, which has that index as its benchmark and rose by 23 per cent.


The best all-share tracker came in 80th, with a 13.7 per cent return, little over half that achieved by the Merrill Lynch UK Dynamic Fund, which takes much more active bets.


The scale of outperformance is more than enough to justify the extra fees charged by active managers - provided, of course, they do deliver superior returns.


That means investors have to choose carefully: beware the closet tracker and follow the good stock-picker, such as those at the Schroder or Merrill Lynch funds.,,1385970,00.html



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