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Trackers look top-heavy as Shell doubles up

THE SUNDAY TIMES (UK): Trackers look top-heavy as Shell doubles up

19 June 2005

ONE of the biggest shares in the FTSE 100 is about to double in size, creating a dilemma for investors with index tracker funds, writes David Budworth.

Royal Dutch/Shell, which is listed on the Dutch and UK stock exchanges, will seek shareholder approval later this month to list solely in London. Shell will make up 6% of the Footsie instead of just over 3% now.

Some advisers are worried that this will make the index too concentrated and dependent on a few companies and sectors, which could blunt returns from tracker funds.

Trackers are most at risk because they will have to increase their exposure to Shell. These schemes do not employ a manager but mirror an index exactly — if Shell accounts for 6%, a tracker fund must hold the same proportion.

The schemes will depend a great deal on natural resources after the Shell move. Oil and mining firms will make up about 25% of the Footsie.

That will benefit the funds while the commodity boom continues. But it makes them more exposed to global trends such as the strength of the Chinese economy.

Paul Ilott of Bates Investment Services, a financial adviser, said: “Following an index worked well for investors in the 1980s and much of the 1990s. But the levels of stock concentration were much lower then.

“The index has become top-heavy, increasing the risk for investors in index trackers. I prefer actively managed funds.”

Ten years ago, the top 10 stocks represented only 23% of the FTSE All-Share, but when Shell moves its full listing the weighting of the top 10 will be more than 42%. The oil, banking, telecom and pharmaceutical sectors already account for more than half of the index.

In a clear sign of the City’s concern about the index concentration, FTSE Group will tomorrow launch new versions of the FTSE 100 and All-Share indexes.

These will limit the amount in any one stock to 5% of the index’s value. BP, HSBC, Vodafone and Glaxo Smith Kline will be capped immediately. So will Shell when its single listing goes ahead.

Next month City of London Investment Trust will replace the All-Share, which it believes is too risky, with an index capped at 4%. But few funds are expected to follow.

So should investors avoid tracker funds? Jason Butler of Bloomsbury Financial Planning said: “The concentration of the index is a risk if you buy a FTSE 100 tracker and that is all you hold. But a FTSE All-Share tracker is fine in a a well-diversified portfolio.”

About 80% of the All-Share index is made up of the same stocks as the Footsie, but Butler claims that the other 20% can still make a difference.

Trackers have low charges and their performance is often better than the average actively managed fund.

They always fall slightly behind the index because fees act as a drag on returns. But the funds usually charge nothing upfront and levy annual fees of 0.5% or less. The M&G Index Tracker, which tracks the All-Share, has no initial charge and a 0.3% annual fee.

Active schemes typically have an initial charge of 5% and a 1.5% annual fee.

The average UK tracker fund has beaten the typical active scheme over the past year. According to Lipper, a data firm, the average tracker has climbed 15.46%. The typical active fund has lagged slightly at 15.15%. Over three and five years the average actively managed fund has produced better returns.

Among actively managed funds, Mark Dampier of Hargreaves Lansdown, an adviser, likes Invesco Perpetual Income, Jupiter Income and Artemis Income.

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