All about trackers
All about tracker funds
What are funds and trackers?
Researching individual stocks can be daunting and for many investors the worry of picking the wrong ones can lead them to consider funds. This means you can choose the asset class, geography or theme to get exposure to the market and then leave the job of filling the portfolio to someone else. There are two types of funds available:
- active funds - a fund manager is paid to make picks
- passive funds - track an index or benchmark
With an active fund, a fund manager will pool your savings with those of like-minded investors and make decisions on what to buy and sell for you. In return for their expertise you pay a fee and to justify the expense the portfolio should at the very least outperform its benchmark and provide consistent premium returns. The downside is not all fund managers outperform at any one time and you might not like paying fees of >0.5% to 1.0% a year to underperform.
With a passive fund, the risk of fund manager error is removed and the fees are lower, usually 0.3% to 0.5% a year but can be as low as 0.1%. The downside is passive funds, known as tracker or exchange-traded funds, will not beat the benchmark index and will instead follow it as best they can. They do this by, replicating the performance of the assets they are tracking - a stock market index such as the FTSE 100, a bond index, a selection of commodities or basket of companies.
Our model portfolios use ETFs or tracker funds and all of the trackers in our list meet the following criteria:
- They are listed on the London Stock Exchange
- They are priced in pounds sterling
- They are compliant with European Union regulations known as UCITS
- They have assets of more than £75 million under management
- They are one of the cheapest options which meet these criteria, using the Ongoing Charge Figure (OCF) as the measure. The OCF is the investing industry’s standard measure of fund running costs and you can find it on the portfolio and build your own pages
The portfolios are designed to feature investments which are eligible for ISAs and SIPPs, regulated by the Financial Conduct Authority, are transparent, with good disclosure of how they work and what they contain. The investments are liquid and easy to trade, at least under most market conditions, and cost effective, particularly for patient investors who resist the temptation to chop and change their portfolio too frequently.
All about trackers. RUSS MOULD, AJ BELL INVESTMENT DIRECTOR
Tracker pros and cons
Exchange-traded funds (ETFs) can be great building blocks for any portfolio:
- Excellent diversification - you can quickly access asset classes, geographies and specific sectors and once you do that, the ETF will provide exposure to an index that is itself a broad basket of securities, adding a further level to your portfolio’s breadth.
- Specialised - you can target a specific theme, such as an individual country or industry or investment theme, such as small caps, while sparing you the burden of researching specific stocks.
- Easily traded and generally liquid, at least during normal market conditions. While you should really resist the temptation to fiddle with a portfolio, as this simply means the expenses tot up.
- Cost effective – annual fees as low as 0.10%, with the standard 0.35% to 0.5%
- Tax efficient - ETFs are not subject to the 0.50% stamp duty and London-listed ETFs are eligible for inclusion in the tax-advantaged ISA and SIPP wrappers.
There are drawbacks and risks of which you must be aware, however:
- If the underlying assets fall in price, so will the tracker or ETF. Remember, financial stock indices can go down as well as up and even a well-chosen, cost effective, tax efficient ETF will have its ups and downs. In volatile market conditions the spreads (the difference between the buy and sell price) for tracker funds can be wider than normal.
- An ETF is unlikely to outperform its benchmark index, merely do its best to track it, minus the impact of its running costs and fees. Some ETFs do outperform, but they do this through sampling replication or by booking fees for lending out their assets, both of which can increase the risk profile.
- ETFs can be subject to tracking difference, whereby they do not exactly deliver the underlying index’s performance. The largest source of tracking difference is typically the expenses incurred in trading and tax withholdings on dividend payments.
- ETFs can also be subject to tracking error, which is the degree of volatility in the ETF’s quoted price relative to changes in the underlying benchmark.
- A London-listed ETF has never failed yet but it is important to keep an eye on the financial health of the product providers. Also, an ETF can be closed down if it is too small and deemed uneconomic to run by the provider.