In the last two decades it has become possible for the likes of you or I to gain exposure to the markets without facing the hefty charges involved in buying actively managed funds.
In the mid-1990s, having previously been the preserve of big financial institutions, tracker funds moved into the mainstream.
More recently these passive mutual funds have been overshadowed by the rise of exchange traded funds or ETFs but if you are used to investing through funds, the humble tracker can be a simple, low-cost way of investing your capital.
As their name suggests, tracker funds track a market index – whether it’s the FTSE 100, the S&P 500, a global index or a Far East index. They are a straightforward way to invest because you simply receive the return of the index being tracked, minus a fee. If the index rises, so does your investment. If it falls, your investment value will drop too.
It’s possible to build a fully diversified portfolio with trackers alone – and you don’t need to invest in a large number of trackers in order to achieve this diversification. A global tracker fund provides exposure to thousands of shares across the world. And tracker funds do not just track equities they can also provide exposure to government and corporate bonds too.
They are cheap, some have annual fees as low as 0.1 per cent compared with the average for actively-managed funds of 0.75 per cent. In some cases, a tracker can be 10 times cheaper than an active fund in the same sector.
A 0.75 per cent charge might not seem huge but costs soon add up and eat into your overall investment returns. According to historic data from Vanguard, around 80 per cent of active funds underperform their benchmarks over 10 and 15 year periods because fees compound over time. The worst sector is US equity, where nearly all active funds underperform their benchmark.
Another advantage of trackers is their transparency – you always know exactly what you’re investing in. With an actively-managed fund you have no way of knowing all the stocks the fund manager has your money in. Most funds only publish a list of their top ten holdings.
The biggest drawback of trackers is there is never an opportunity to get market-beating returns. A tracker can only ever, by definition, track the market and although fees are modest, they still exist. This means they will always return slightly less than the market they are tracking.
However very few active managers consistently outperform their benchmarks and over the long-term the returns from the wider market stack up.
The tracker versus active fund debate often boils down to which market you want to invest in. Trackers tend to work best in very liquid markets – where the market is traded very heavily, a lot of information is quickly available about its constituents and indices are efficient, cheap and easy to trade in.
This means it is less likely the market will have got the share price of a stock wrong. In less liquid markets where the stories of individual companies are less well understood, fund managers can add more value.
Blackrock 100 UK Equity Fund
Ongoing charge: 0.07%
Top tracker for UK stocks in general
BlackRock UK Equity Tracker
Ongoing charge: 0.06%
Top tracker for US stocks
Vanguard US Equity Index
Ongoing charge: 0.1%
Top tracker for global stocks
Legal & General International Index Trust
Ongoing charge: 0.13%
Top trackers for bonds
Vanguard Global Bond Index
Ongoing charge: 0.15%