Credit Suisse Warns on Oil, Mining Dominance of UK Blue-Chips

Tom Burroughes

20 June 2008

UK tracker funds are increasingly at risk of a sharp correction in the oil price because oil, gas and mining firms are making up a substantial chunk of the domestic stock market, argues a senior equities fund manager at Credit Suisse.

Graham Ashby, head of retail UK equities at Credit Suisse, warns investors that UK equity tracker funds are increasingly exposed to the Oil & Gas and Mining sectors. FTSE International, the index provider, has recently announced its quarterly changes to the composition of the FTSE 100 Index, including the entrance of two new resources companies: Ferrexpo and Petrofac. This takes the number of mining constituents in the FTSE 100 Index up to ten, with a further seven in the Oil & Gas sector, Credit Suisse said.

The 10 largest stocks in the FTSE 100 - such as banks, miners and oil & gas firms - account for about half of the index's weight by market cap.

"As these companies collectively account for 50 per cent of the FTSE 100 Index's total market capitalisation, there is an increased concern that investors in UK tracker funds are heavily exposed to what have historically been very cyclical industries," the bank said in a note.

The comment comes at a time when the oil and gas sectors have boomed on the back of sharp rise in the price of oil. However, although analysts say it is tough to predict when the market will turn, they say a sharp pullback is likely to happen if supply and demand for oil reverts to long-term historical patterns.

The Swiss bank's comments also are a reminder that investors in national stock market benchmarks like the FTSE 100 or the S&P 500 must watch for signs that an index is becoming particularly concentrated towards one or more types of industry, as this can adversely affect returns if these sectors slow down.

At the end of March, UK tracker funds had Â£24.5 billion of funds under management and accounted for nearly one third of net retail inflows over the previous quarter. Index trackers have often proven to be popular with investors due to their low annual charges, and have recently performed better than many actively managed funds by buying into the "hot" commodity areas of the market. Tracker funds also typically have less exposure to mid- and small-cap stocks which have underperformed over the past eighteen months.

However, the drawback of tracker funds is that, as their investments are pre-determined by the makeup of the index they track, they do not always offer investors enough diversification and, as is the case currently, can be over exposed to certain sectors of a cyclical nature.