Lisa Buckingham
The Bank of England has begun a discreet investigation into index tracker investment funds. It is worried that the burgeoning growth of such “passive” stock market vehicles risk destabilising London’s financial markets.
A team of senior executives in the bank’s financial stability unit is monitoring the issue amid growing fears that tracker funds have the power to create abnormal volatility in share prices. The proportion of tracker funds has increased sharply in recent years, partly because they are cheap to run and will, by definition, turn in a performance in line with overall market movements.
Tracker funds are thought to own about a quarter of all United Kingdom shares directly, although shadow or “closet” trackers probably speak for another 5% or 10%. The issue concerning the bank and a large proportion of active investment managers is the power of the trackers to distort “normal” market behaviour.
The impact of trackers is now so important that a company such as 3i, the investment group, admitted that one of the reasons behind its 1,75-billion bid for Electra was to ensure its continued presence in Britain’s premier index. When a company enters the FTSE 100, index trackers buy large slugs of shares, thereby boosting the price, but these are sold the second a company falls out of that index.
This type of investment behaviour has already had a distorting impact, but while the market has been rising the impact has been positive – albeit at the expense of smaller companies whose shares have been ignored.
The bank is thought to be concerned at the damaging impact which would emerge if markets started to fall. Trackers would be forced to sell more and more as share prices fell, but their selling would be self-fulfilling and would drive prices even lower.
The bank believes markets should operate in a “rational” manner, whereby shares are bought on their individual merits, rather than an “irrational” one based solely on whether a company is or is not included in an index.