Financial Times: Tracker funds bulk up in Shell shares: Saturday 9 July 2005

By Robert Budden

Published: July 9 2005

Fluctuations in the oil price will have an even bigger impact on the UK stock market come July 20 when the unification of different Shell share classes formally takes effect. The change will turn oil and gas shares into the biggest constituents of the FTSE 100 index and, following a strong recent run on its shares, Shell looks set to become the biggest company in the FTSE, narrowly beating the other UK-listed oil giant BP.

Under the changes, Shell Transport & Trading and Royal Dutch Petroleum, the London and Netherlands arms of the global oil group, will be unified into Royal Dutch shares. Shell currently makes up 4.4 per cent of the FTSE 100. From July 20, this will rise to about 10 per cent.

Index tracking funds, which build portfolios designed to mirror stock market indices, have been monitoring developments for months in search of the best moments to increase their weightings in Shell. Some speculate that the recent strong run in Shell shares has been driven partly by index tracking funds which have been quietly building up their stakes ahead of Shell's much bigger index weighting.

But Shell shares could have further to go, driven by strong demand from active and passive fund managers.

"With traditional patterns of index changes, you find that there is pressure on the buying side," says Eleanor de Freitas, head of index strategy at Barclays Global Investors, one of the world's largest managers of tracking funds. "Further share price rises are possible."

The oil and gas sector currently makes up just over 16 per cent of the FTSE 100, comfortably behind banks and financials which make up almost 22 per cent. But following the Shell unification, oil and gas shares will account for more than 21 per cent of the FTSE with banks and financials falling to around 20.5 per cent.

Shell's increased weighting could also cause problems for fund managers as rules do not permit them to invest more than 10 per cent of their funds under management in any one stock. Many actively managed funds will therefore find it very tough to achieve an overweight position in Shell or BP.

And tracker funds may be forced to find creative ways to mirror the performance of Shell should its weighting rise much above 10 per cent. Some tracker managers will achieve additional Shell exposure by buying derivatives designed by investment banks to perform like Shell shares. Others will buy shares in alternative oil and gas stocks with similar performance characteristics.

Because of the powerful influence of the biggest stocks in the FTSE, L&G has created a FTSE All Share index tracking fund that strips out the top five stocks. This fund is only open to institutional investors.

For some financial advisers, the unification of Shell shares further heightens the sector specific risks of the FTSE. Following the Shell changes, the four biggest sectors - including also telecoms and pharmaceutical stocks - will account for almost 60 per cent of the FTSE 100 index.

Advisers suggest investors who have index tracking funds at the core of their portfolio take a look at how heavily they are exposed to the oil and gas sector. This will be important for investors who also have exposure to commodities as they are likely to find their investment portfolio is sensitive to fluctuations in the oil price.

One way to trim exposure to oil and gas stocks is to seek out actively managed funds that have underweight positions in the dominant FTSE sectors. For example, Neil Woodford, who manages the Invesco Perpetual Income and High Income funds, has minimal exposure to oil and gas stocks and banks and financials. Instead he favours tobacco stocks and utilities.

According to Hargreaves Lansdown, a firm of financial advisers, several funds with minimal exposure to oil and gas include Rensberg's UK Select fund (with 4 per cent exposure to oil and gas) and Schroder's UK Alpha Plus with 2.5 per cent.

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