Do tracker funds have a place in your portfolio?

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Investors poured record amounts of money into tracker funds in March.

Passive investment vehicles that mirror the stock market saw net retail sales of £938m, the highest ever monthly inflow.

Although tracker funds have been a familiar part of the investment landscape for some time, the products account for only a small proportion of the fund market overall.

Mark Dampier of Hargreaves Lansdown says tracker funds are often been perceived as the preserve of those new to investment, who lack the time to actively manage their own portfolios and the resources to afford a fund manager.

This perception is now changing, he says.

Trackers have grown to account for 11.5 per cent of the fund market. The total amount held in trackers recently exceeded £100bn for the first time.

Dampier says trackers are starting to feature prominently in the portfolios of experienced investors. Much of this, he believes, is due to the increasingly popular view that fund managers don’t offer much in the way of value or reward.

“The argument that actively managed funds deliver better returns due to superior expertise and resources isn’t consistent with reality,” says Dampier.

An investigation into active vs. passive management compiled by Vanguard Investment Research concluded that “there is little evidence to support the theoretical benefits of active management”; last year, veteran investor Warren Buffett declared that investors in the US were best served by the S&P 500 Index Tracker.

Most trackers are free to set up, and charge annual fees significantly lower than 1 per cent. This is in contrast to active funds, which can demand upfront fees of up to 5 per cent, and annual charges of over 1.5 per cent.

If you were to invest £10,000 for 10 years at an annual growth rate of 6 per cent, this sum would rise to £19,185 in a tracker with an 0.25 per cent fee; in an actively managed fund with a minimum annual fee of 1.5 per cent, this figure would increase to £16,929 at a maximum.

However, tracker funds are not without disadvantages. “I have heard people refer to trackers as ‘risk-free’ from time to time – I’ve no idea how widespread that view is, but it is worryingly inaccurate,” says Dampier.

By definition, trackers attempt to emulate the movements of an index. Therefore, falls in a stock market are detrimental to a tracker fund. If a tracker mimics the fortunes of a volatile market, or is focused on a sector that suffers particularly badly during an economic downturn, harsh falls are a very real prospect. “Trackers are no panacea – and by traditional index trackers can lead to very concentrated exposure” says Jason Hollands, managing director of investment group Tilney Bestinvest.

“Active managers can also move proactively to protect capital in a falling market, by raising cash and investing in defensive stocks – this isn’t an option with tracker funds,” Hollands adds.

Furthermore, tracker funds remain a niche vehicle; there are currently 116 trackers, vs. over 2,000 actively managed funds, significantly restricting investment options.

However, for Dampier, a singular focus on trackers is as unsound an investment approach as exclusively using active funds. “There are exceptionally good funds, and exceptionally good trackers – why not combine the two?” he says.

Choosing a tracker

If your appetite for tracker funds has been whetted, Adam Laird of Hargreaves Lansdown, whose role is to identify the best trackers, suggests that investors look for broad indices which give an unbiased coverage of their market.

“Next, look at the fund’s record and its management – you not only want to make sure that the fund has tracked its index closely in the past, but that it will continue tracking well in the future,” he says.

Laird’s top picks for new investors:

  • Legal & General UK Index

This fund tracks the FTSE All Share Index, a 600-share broad indices of UK listed shares. Legal & General have over 25 years’ experience running tracker funds, and are averse to risk. There is an annual charge of 0.06 per cent.

  • Legal & General International Index Trust

This tracker offers extensive international coverage, including hundreds of shares from North America, Europe and Asia. With an ongoing charge of 0.09 per cent it is one of the cheapest ways to access a diverse range of global companies.

  • BlackRock Corporate Bond Tracker

BlackRock’s fund invests in over 1,000 bonds; with an annual charge of 0.12 per cent, it is the cheapest bond fund available to investors.

Laird’s top picks for more experienced investors:

  • HSBC FTSE 250 Index

The FTSE 250 Index covers smaller companies than those in the well-known FTSE 100 index; while individual shares tend to be riskier, the index has consistently produced better returns than its larger counterpart. Annual charges are low at just 0.07 per cent.

  • BlackRock Emerging Markets Equity Tracker

Shares in emerging markets have considerably outperformed developed markets in the past decade, but this comes with greater risk. There is an ongoing charge of 0.25 per cent.

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