Outlook: Market indices

THE DANGERS of fiddling around with stock market indices in order to appease the fund managers who trade the shares rather than the companies who issue them was plain to see yesterday.

The proposal from FTSE International to link the index weighting of individual shares to the proportion that are freely available to be traded sounds innocent enough. So does the idea of preventing double counting by excluding from the market value of one company, the stake held in it by another constituent of the same index.

But these proposals produced no shortage of casualties yesterday. Energis and Telewest, which would both fall out of the Footsie under the new rules, felt the pain as did BSkyB, which would carry a much smaller index weighting than it does now.

Cable & Wireless Communications, which would spring into the index, rose in anticipation of all those tracker funds piling in.

Unsurprisingly, fund managers are rather keen on the proposed changes. The trackers, who now own a tenth of the UK market and operate mostly on autopilot, would only need to wake up for as long as it took to dispose of those stocks in which they were suddenly overweight.

The active fund managers say it would give them more chance to get their hands on shares which are in short supply such as telecom stocks which the trackers gobble up before anyone else.

But it would not solve the problem of index powering - the phenomenon whereby the trackers have to keep buying in order to maintain their weightings, thereby pushing the index higher each time. Nor would it solve the problem of companies such as BP Amoco which now accounts for just under 10 per cent of the index and could soon become a stock which tracker funds can no longer keep buying.Indeed, it would exacerbate BP Amoco's problems in the short-term because its weighting would rise further as those of other companies fell.

FTSE International's answer is that BP Amoco's weighting will fall as other mega companies, like Vodafone-Airtouch enter the index. If that still doesn't solve the problem, then it is launching a multi-national index this autumn where investors can find BP Amoco alongside other monsters like Exxon-Mobil and DaimlerChrysler.

None of these changes to the indices would be quite so necessary, of course, if the active fund managers were better at selecting stocks. Their defence is that it is harder to beat the index in a bull market than a bear market. But, as the old saw goes, if they can't pick the winners on the way up, why should they avoid the losers on the way down?

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