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Passive tense as FTSE floats free

Passive fund managers are having to make serious upheavals to index tracker funds after changes to the way the FTSE evaluates companies.

From close of trading last Friday, the FTSE will exclude any strategic holdings that normal investors cannot participate in when calculating index weighting.

This means cross-holdings from other companies, family-owned or Government-owned shares will no longer be included in the company&#39s value. Only share capital that is freely available for trading will be considered.

Passive fund managers will have to trade huge volumes of shares in tracker funds to replace stocks which fall out of the indices.

This free float stance applies across all FTSE markets. In Europe excluding the UK, there will have to be a 19 per cent turnover of stocks.

BMW is an example of a company where the weighting will be reduced. Nearly half the company is family-owned so its current weighting will be cut as only half the company is available to investors. Telecom Italia and Munich Re will also be reduced whereas BP and HSBC will have their weightings increased.

Gartmore senior fund manager Derek Quinn says: “There will be a lot of pressure on large index fund managers. They will have to buy stocks going up in weight and sell those whose weighting is being cut. Everyone will be offloading the same companies at the same time because they will be forced to find alternative holdings.”

Fund managers have been aware of the changes for some time and most have been preparing for the shifts.

Legal & General index funds managing director Tim Breedon says: “Although many companies are affected, the relatively small size of the changes that are req-uired means very little impact and little turnover.

“The introduction of free float rules across markets is a sensible development. It reflects evolving investor needs and minimises possible market distortions. Our implementation plan is under way and will aim to spread the required trading to minimise market impact and contain market costs.”

The UK only needs a 4 per cent turnover of stocks while market capitalisation in Japan will drop by 23.9 per cent because of high levels of corporate cross-holdings.

However, Legal & General says it will not execute large trades because where it has a fixed weighting in a global fund, cashflows can be used to adjust weightings. It says it only has to switch less than 9 per cent of assets in its Japanese pooled index fund.

Many IFAs think the free-float rules will have little effect on tracker funds.

Michael Philips partner Michael Both says: “This should not really affect investment in tracker funds. Once the trading has settled down, this will probably make little difference. Changing the index more towards free floating can only be a good thing.”

The change to consider only shares that can be traded when valuing a company is welcomed by many IFAs and fund managers.

They say the indices will be more reflective of true market capitalisation because it prevents firms from being over-represented.

Simpsons partner Andrew Merricks says: “A change in the make-up of the index will create a good opportunity for the active manager as they can use this situation to their advantage. Anything that gives a better reflection of market capitalisation and availability of stocks is positive.”

LM Financial adviser Steve Butt-ercase says: “The FTSE has been accused of being inaccurate because it overly weights stocks. It is, how-ever, very early to see what effect these changes will have. IFAs should be reconsidering tracker funds anyway. It is a stockpicking market.”

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