Fund Briefing: the pros and cons of tracker funds

27 March 2019

Finding a fund manager who consistently performs above average can be difficult. In fact, a record £54.6 billion is currently invested in funds that underperform, according to Bestinvest’s annual ‘Spot the Dog’ research.

When you consider how much you pay for the privilege of a manager running a portfolio, the harsh reality is that it is depressingly easy to end up seriously out of pocket even if your money is with well-known investment houses.

It is one of the reasons why passive funds – also known as index trackers – have become so popular. 

Passive funds are much cheaper than active funds because you are not paying someone to make daily decisions about which funds to buy and sell.

Instead, these products aim to mirror the performance of a particular asset class or index.

For example, the FTSE 100 is a list of the 100 largest companies on the London stock exchange. A passive fund that tracks the FTSE 100 simply aims to buy shares in each of those 100 companies.

Passive funds generally buy either every single constituent of an index or a representative sample.

The value of tracker funds now totals £181 billion – 15.7% of all investment funds, according to the latest figures published by the Investment Association. It is a statistic that doesn’t surprise Patrick Connolly, a chartered financial planner with Chase de Vere.

“They are the perfect option for those who are disillusioned with the higher costs of actively managed funds, don’t believe active managers can consistently outperform, or who want a simple, long-term, buy-and-hold core exposure to a particular sector or asset class,” he says.

The cost difference between active and passive funds is a big draw, according to Mr Connolly. While the typical annual charge on a tracker fund is around 0.1%, he suggests the rate on an active portfolio might be 0.75%, meaning these products start at a disadvantage.

However, he points out they’re not always the cheapest option, while the fact that many can only be bought on a platform – which is likely to come with additional charges – must also be taken into consideration.

“Platform charges are typically between 0.25% and 0.45% a year, so even for a lower-cost passive fund, an investor is likely to be paying total charges of between 0.35% and 0.55% a year,” he explains.

Low costs, low risk and relatively predictable returns are positives, but there are also potential negatives to consider, according to Carl Melvin, managing director at Affluent Financial Planning.

“The cons are the inability to over- or underweight, or make tactical decisions, while active management can sometimes outperform the benchmark,” he says.

The good news is there is certainly no shortage of passive funds – both traditional index funds and Exchange Traded Funds (ETFs). However, they are not a guaranteed route to riches, warns Martin Bamford, a chartered financial planner at Informed Choice.

“One disadvantage of using index trackers is that they follow markets down as well as up,” he explains. “During falling markets, actively managed funds have the potential to protect investors from some of this downside risk, although of course this isn’t guaranteed.”

Mr Bamford believes you need a discussion about risk and asset allocation before deciding which passive fund might best suit your needs. The goal, he points out, is designing a portfolio that is capable of achieving your long-term financial goals.

“Only when you’ve decided on the broad asset allocation, with a split between bonds, equities and other mainstream investment types, should you populate these with funds,” he explains.

“When you compare trackers, you should take into account charges, the indices they seek to track, their method of replication, and their regulatory status.”

There will be other factors to consider, depending on the area of the world you are focusing on, according to Adrian Lowcock, head of personal investing at Willis Owen.

“If you are getting exposure to a particular market such as North America or Asia, it is important to know what index it is tracking as some might exclude certain regions or countries,” he says. “You’ll need to make sure you are getting the exposure you want.”

The investment spread is not always as wide as you might think, due to ‘weighted’ indices, and the best active managers might comfortably outperform the index, points out Justin Modray, founder of Candid Financial Advice.

“Many indices are weighted, meaning larger companies dominate the index,” he says. “For example, although the FTSE 100 comprises 100 companies, the largest 10 companies typically account for around 40% to 50% of the index.”

Mr Modray suggests looking at tools such as Morningstar to look at a fund’s track record and tracking error – defined as the extent to which the portfolio’s performance has strayed from the index it was following.

“It generally makes sense to combine a range of trackers to ensure a sensible level of geographical and sector diversity,” he says. “You don’t want all your eggs in one basket.”

Fund: Vanguard FTSE UK All Share Index
ManagerVanguard Investments UK Ltd
Launch date  04-Dec-09
Total fund size£5.9 billion
Minimum initial investment £500
Monthly direct debit£100 
Initial charge/Ongoing chargeNone/ 0.08%
Other charges0.15% platform charge if fund is bought directly from Vanguard
Annual management feeAs above, there are no entry or exit charges
Performance feeNone
Contact details for retail investors0800 587 0460; Vanguard

One to watch: Vanguard UK All-Share Index

The aim of the fund is to track the performance of the FTSE All-Share Index, which is comprised of a range of large-, mid- and small-cap companies in the UK.

It works by investing in a representative sample of index constituents and attempts to remain fully invested, with only a small amount in cash.

The fund, which was launched almost a decade ago, has £5.9 billion of assets under management, according to its most recent factsheet.

There are 572 stocks represented in the portfolio – compared to 637 in the benchmark – with the largest holdings including Royal Dutch Shell, HSBC Holdings and BP.

As is often the case with passive investments, the fund is run on a group basis – in this case overseen by the Europe Equity Index team.

Adrian Lowcock, head of personal investing at Willis Owen, likes the fund and highlights the benefit of following the benchmark for the lowest possible cost.

“It has done just that since its inception in 2009,” he says. “The fund has lagged the FTSE All-Share Index by 0.10% on average every calendar year, and its tracking error has been minimal.”

Mr Lowcock suggests the fund is a compelling option for those looking to establish a core portfolio allocation to UK equities. 

“By tracking the FTSE All-Share Index, this fund provides broad and well-diversified exposure to the UK stock market,” he adds.

ROB GRIFFIN writes for the Independent, Sunday Telegraph and Daily Express.

In reply to by anonymous_stub (not verified)

The ongoing charge is 0.08% not 0.8% as in your table.

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