Should you invest in tracker funds?
This approach sees them buying into so-called tracker funds, whose aim is to mirror the performance of a particular index, rather than trying to beat it.
In fact, their enthusiasm for these solutions has seen sales rocket over the past few years.
There is currently £106.8 billion invested in this area, according to figures compiled by the Investment Association, which equates to a 12.1% share of the industry's total funds under management – up from 9.9% a year ago.
The big advantage of tracker funds is they are usually much cheaper than their active counterparts – and increased industry competition has led to fees falling substantially, points out Patrick Connolly, a certified financial planner with Chase de Vere.
"They provide an ideal solution for long-term investors who don't have the time, inclination or knowledge to regularly review their investment funds," he says. "Most people with a tracker shouldn't go too far wrong."
Another advantage of passives is that many active managers consistently fail to outperform in more efficient markets, particularly large-cap UK and US equities.This is principally because analysts very closely follow companies in these areas, leaving little unexplored areas where good managers can seek value and growth.
When you factor in that many investment funds are heavily promoted when they are riding high in the performance tables, only to falter over the longer term due to a combination of poor manager decisions and high costs, it's clear that active management comes with risks.
It's a point illustrated by the Spot The Dog report, published by Bestinvest, which names and shames those funds that have consistently and significantly underperformed. The most recent version of the study, published earlier this year, identified 60 such funds.
"This study doesn't make us popular with fund managers but the reality is that most funds fail to beat their benchmarks and there is far too much of people's hard-earned money stagnating in funds with abysmal performance records," said a spokesperson.
For those who like the sound of passive investing, the good news is there will be something to meet their needs, with trackers following virtually every index around the world, although UK investors are most likely to consider those that track a prominent index in this country, such as the blue-chip FTSE 100 or FTSE All-Share.
The fund manager at the helm will buy stocks in the same proportions as they appear in the index, although different methods, such as full replication and sampling, may be used. This means they may be run in different ways, despite having the same objective.
The packed mutual fund arena has also been joined by a dynamic young rival in the shape of Exchange Traded Funds and, even more recently, Exchange Traded Commodities, which have allowed investors to track a host of exciting areas.The result is a lot of choice.
The various benefits make trackers a viable option for buy-and-hold investors who have longer-term horizons, as well as those who want broad exposure to a marketplace and are more in favour of a slow and steady approach.
"They don't want to be regularly reviewing their investment funds and making changes," points out Connolly. "By using a tracker, investors don't need to worry about their manager underperforming significantly or leaving."
However, it is not a guaranteed route to riches. While replicating an index means they will go up in line with increases enjoyed by this benchmark, it also means they will fall in value should it take a turn for the worse.
Trackers can also suffer disproportionately if dominant sectors in an index suffer. For example, when the banking and oil areas go through difficult times, this could have an adverse effect on funds tracking the blue-chip FTSE 100 which contains a lot of them.
Also, once charges have been taken into account, most trackers are likely to underperform their benchmarks.This could potentially limit growth potential, particularly when markets are moving sideways or large-cap companies are performing badly.
As an aside, it's worth noting that top active managers can find opportunities in less efficient areas, such as smaller-cap companies or the emerging markets, due to a combination of their own skills and the fact these areas can be overlooked.
As a result, there is an argument that investors may find the best approach is to hold a combination of active and passive investment funds, with trackers forming the core of the portfolio and the active funds acting as satellite holdings around the edges.
A general rule of thumb is that active funds should be held in sectors where the fund manager has a better opportunity to outperform, while passives are best considered where outperformance is much less likely.
All investment returns are measured against a benchmark to represent “the market” and an investment that performs better than the benchmark is said to have outperformed the market. An active managed fund will seek to outperform a relevant index through superior selection of investments (unlike a tracker fund which can never outperform the market). Outperform is also an investment analyst’s recommendation, meaning that a specific share is expected to perform better than its peers in the market.
Also known as index funds, tracker funds replicate the performance of a stockmarket index (such as the FTSE All Share Index) so they go up when the index goes up and down when it goes down. They can never return more than the index they track, but nor will they lose more than the index. Also, with no fund manager or expansive research and analysis to pay, tracker funds benefit from having lower charges than actively managed funds, with no initial charge and an annual charge of 0.5%.
An individual employed by an institution to manage an investment fund (unit trust, investment trust, pension fund or hedge fund) to meet pre-determined objectives (usually to generate capital growth or maximise income) in prescribed geographic areas or investment sectors (such as UK smaller companies, technology or commodities). The manager also carries the responsibility for general fund supervision, as well as monitoring the daily trading activity and also developing investment strategies to manage the risk profile of the fund.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
A term applied to raw materials (gold, oil) and foodstuffs (wheat, pork bellies) traded on exchanges throughout the world. Since no one really wants to transport all those heavy materials, what is actually traded are commodities futures contracts or options. These are agreements to buy or sell at an agreed price on a specific date. Because commodity prices are volatile, investing in futures is certainly not for the casual investor.
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
A standard by which something is measured, usually the performance of investment funds against a specified index, such as the FTSE All-Share. Active fund managers look to outperform their benchmark index. Cautious fund managers aim to hold roughly the same proportion of each constituent as the benchmark, while a manager who deviates away from investing in the benchmark index’s constituents has a better chance of outperforming (or underperforming) the index.
A market-weighted index of the 100 biggest companies by market capitalisation listed on the London Stock Exchange. It is often referred to as “The Footsie”. The index began on 3 January 1984 with a base level of 1000; the highest value reached to date is 6950.6, on 30 December 1999. The index is “weighted” by how the movements of each of the 100 constituents affect the index, so larger companies make more of a difference to the index than smaller ones. To ensure it is a true and accurate representation of the most highly capitalised companies in the UK, just like football’s Premier League, every three months the FTSE 100 “relegates” the bottom three companies in the 100 whose market capitalisation has fallen and “promotes” to the index the three companies whose market capitalisation has grown sufficiently to warrant inclusion. Around 80% of the companies listed on the London Stock Exchange are included in the FTSE 100.