The Sunday Times (UK): Do big stocks pose a threat to trackers? Some experts worry that funds that follow the UK market are too dependent on a few firms such as Shell.: “some are worried by the news that Royal Dutch/Shell, which is currently listed on the Dutch and UK stock exchanges, is planning to list solely in London” (ShellNews.net) 7 Nov 04

By David Budworth

November 07, 2004

THE average UK tracker fund has beaten the typical active scheme over the past year, but some experts are nervous that their performance is becoming too reliant on a few big stocks.

Trackers do not employ managers to pick shares but simply follow an index such as the FTSE 100. Consequently they have low charges and their performance is often better than actively managed schemes.

The average tracker climbed 10.9% in the year to the end of October, according to Lipper, a data firm. The typical active fund lagged slightly at 10.7%.

Many advisers recommend tracker funds as a solid foundation for investment portfolios.But some are worried by the news that Royal Dutch/Shell, which is currently listed on the Dutch and UK stock exchanges, is planning to list solely in London. The company plans to seek shareholder approval for the move in April next year.

Overnight, Shell will in effect double in size — it will make up about 8% of the Footsie instead of just under 4% now. A few stocks from the oil, banking, telecom and pharmaceutical sectors already account for more than half of the FTSE 100.

Jason Day of Allenbridge, a discount broker, said: “The FTSE 100 is already very concentrated and the increased weighting of Shell will make matters worse.

“The performance of a tracker depends on sentiment towards a handful of stocks and sectors. If sentiment turns negative there is nowhere to hide.”

Oil and mining stocks will make up about 25% of the FTSE 100 when Shell moves its listing. Tracker funds will have no choice but to increase their weightings in Shell and the oil sector.

Most of the companies in the Footsie are already dependent on overseas earnings. But Shell’s decision will make the index even more reliant on global trends such as the strength of the economy in China, the world’s biggest consumer of commodities.

Funds that track the FTSE All-Share index will also have to increase their exposure to the resources sector. About 80% of the All-Share is made up of the same stocks as the Footsie. After the Shell move, oil and mining firms will make up more than 21% of the All-Share.

So should investors avoid tracker funds? Julian Penniston-Hill of Intelligent Money, a discount broker, will continue to recommend trackers. He said: “Active managers argue that trackers are too concentrated. But the fact remains that even though some active schemes outclass trackers over the long term, few do so consistently.”

Trackers always fall slightly behind the index because fees act as a drag on returns. But charges are usually low, so the drag should be small.

The funds usually charge nothing upfront and levy annual fees of 0.5% or less. Active schemes typically have an initial charge of 5% and an annual fee of about 1.5%. They therefore have to perform much better just to keep pace.

The evidence suggests few make the grade. A survey of 20 of the most popular UK growth funds by Intelligent Money found only three had beaten the market over the past decade, partly because of high fees.

Active fund managers have largely ignored pressure to cut charges. In fact, fees are rising, according to McKinsey & Co. The consultancy blamed the rising cost of employing star fund managers and an increase in the number of specialist schemes, which tend to have higher charges.

But some mainstream funds have been pushing up costs. Fidelity, Invesco Perpetual and Legal & General have all announced fee increases over the past year. Invesco Perpetual, for example, has hiked the annual charges on its popular Income and Higher Income funds from 1.25% to 1.5%.

Justin Modray of Bestinvest, an adviser, thinks investors who want exposure to larger companies should stick with a lower-cost tracker.

He said: “It is extremely difficult for fund managers investing in larger companies to beat the index. The changes to the Footsie will not alter that. However, we would recommend that you choose a fund that tracks the All-Share, not the FTSE 100 because it will give you a little more diversity.”

When choosing a tracker you should pick the one with the lowest charges. The M&G Index Tracker fund is the cheapest, according to the Financial Service Authority’s tables. The scheme, which tracks the All-Share, has no initial charge and an annual fee of 0.3%.

An alternative is to buy exchange-traded funds from a stockbroker. They work like trackers but you can buy and sell them like shares, so it is easier to move in and out of the market in volatile periods. The typical annual charge is 0.35%, but you have to pay share-dealing costs when you buy and sell. They are not liable for stamp duty.

Investors who prefer active funds are being urged to weigh up whether they are getting good value for money.

If you are paying over the odds for poor returns, you should consider a switch to a fund that offers better value.

Day recommends Lazard UK Alpha, which is up 10.3% over the past year. It charges 3.75% upfront and 1.5% annually, although you can buy it for less through a discount broker or fund supermarket. However, the fund can be volatile.