Making glib comments about the flaws of tracker funds ? or even more so the foolishness of those who invest in them ? is a mug’s game. The evidence shows that over the long term, tracker funds beat most actively managed ones, not least because of the far higher costs of keeping a fund manager in Ferraris, versus plugging an old PC into the mains and dusting it now and then. Okay, I exaggerate? but only a little. However strange it may seem, warts-and-all tracker funds holding a seemingly sub-optimal mix of shares tend to beat the…
Making glib comments about the flaws of tracker funds – or even more so the foolishness of those who invest in them – is a mug’s game.
The evidence shows that over the long term, tracker funds beat most actively managed ones, not least because of the far higher costs of keeping a fund manager in Ferraris, versus plugging an old PC into the mains and dusting it now and then.
Okay, I exaggerate… but only a little.
However strange it may seem, warts-and-all tracker funds holding a seemingly sub-optimal mix of shares tend to beat the majority of carefully chosen portfolios – even though a fund manager is free to avoid the basket cases and double-down on the good companies that seem cheap.
But what does this have to do with Royal Dutch Shell (LSE: RDSB)?
Well, thanks to its upcoming merger with BG Group (LSE: BG), Shell is set to become by far the largest publicly listed company in the UK – and thus a truly massive component of UK tracker funds.
Already, Shell battles daily with the similarly sized HSBC (LSE: HSBA) for the title of UK top dog.
But – assuming the deal goes through – the bolt-on of £37 billion BG Group will put Shell well in front.
And that’s before any potential recovery in the beaten-up oil sector.
In fact, simply studying the holdings of a fund like the iShares Core FTSE 100 ETF (LSE: ISF) shows the combined entity could comprise 9% of a FTSE 100 tracker fund.
That compares with about 6.5% today.
Will most FTSE 100 tracker fund investors of the future understand they’re putting nearly £1 in every £10 into just one company?
I doubt it!
Even more notable, however, is that according to financial data firm Markit, the combined Shell/BG group could be responsible for nearly 10% of the dividends paid out by the FTSE 100 index.
That’s a remarkable figure – and potentially a risky one.
You see, while companies have no say over how they or their peers happen to be valued by the market at any given time – and thus can’t directly influence what proportion of the index they comprise from day-to-day – the dividend payout is entirely under their board’s control.
And the Shell board’s duty is to its shareholders.
What if the oil price rout we’ve seen in recent years persists? Or if the high capital expenditure that has been such a feature of BG Group’s accounts turns out to have a few more rounds to go?
What if Shell’s management decides that less cash should leave the company’s coffers, and thus cuts the dividend?
For all those private investors who bought Shell for its whopping 6.5% dividend yield, that’s obviously going to be a problem.
But the sheer size of the combined Shell/BG Group will make it most other investors’ problem, too, whether they’re invested in tracker funds or actively managed funds that own a big chunk of Shell – or they’re among the millions who directly or indirectly rely on Shell for some portion of their pension.
You can be sure-ish of Shell
Let’s not get carried away.
Shell hasn’t cut its dividend since the outbreak of World War 2.
And when its CEO Ben van Beurden told Bloomberg earlier this year…
“The dividend is an iconic item at Shell and I will do everything to protect it”.
… I believed him.
However, it’s easy to come up with scenarios where van Beurden is pressed for options – even just as a result of consummating the BG merger.
Shell wouldn’t be the first company to discover skeletons in the cupboard post-acquisition, after all.
My point is the enlarged Shell/BG group will be such a massive component of the UK market that everyone will need to pay attention.
That’ll be true whether they’re income seekers who bought Shell for its yield or just savers socking money into a FTSE 100 tracker each month.
Don’t bet on it
Of course, not every last income seeker seeks to own Shell.
The legendary fund manager Neil Woodford has long shunned the oil majors, for instance.
I’ve heard no word that the proposed merger has changed his mind.
For Woodford, not owning the enlarged Shell will be an even bigger contrarian bet against the market.
Fund managers live or die on their performance versus their benchmarks.
However, we private investors can roam more freely.
We can invest in whatever we like without fear of being challenged as to why we don’t hold a company that makes a big chunk of the index – or even why we don’t own a similarly sized amount of it.
This flexibility might just enable us to create a safer, less volatile income stream, if not necessarily a more rewarding one.
Getting out of your shell
I own Shell shares, for instance, partly for the big dividend, but I don’t have 6.5% of my portfolio in it.
Let alone 10%!
The reality is there are plenty of other companies with good dividend records you can consider for an income portfolio.
The best-performing share on the income-oriented Ice side of the Motley Fool’s Share Advisor scorecard has a market cap of less than £3 billion.
That’s barely a drop in the index’s ocean, compared to the Shell/BG super tanker coming our way! But what does size matter if you’re simply interested in investing for a growing income, as opposed to bragging you own the biggest beast in the jungle?
Don’t be shell-shocked
As I said at the off, index funds have a great track record. The potential size of the Shell/BG combination isn’t per se a reason to think trackers will suddenly start to do badly.
But I do believe they become riskier as they become more concentrated.
For income seekers for whom stability of income is more important than total returns – especially pensioners and the like – relying on one company to deliver 10% of your dividends seems to me to stretch prudence.
You can be sure of Shell. But perhaps not that sure!
Owain owns shares in Royal Dutch Shell. The Motley Fool has recommended shares in HSBC.