How do tracker funds add value?Posted on: 14 July 2009 by Gareth Hargreaves
Independent financial advisor Peter McGahan investigates the uses of tracker funds and finds out whether they really do add value.
I remember back when Virgin Money hopped on the tracker bandwagon years ago with the line that active investment managers rarely performed well and indeed charged heavily for it.
Trackers claim to be cheaper entries into the investment market and typically appeal to an investor through cost but many investors are paying way through the nose for such a scheme. Fidelity international for example cut their costs to 0.1% per year (a tenth of the cost of most competitors) back in 2005. Many investors in tracker funds have been caught by that apathy and still pay the extra fee unnecessarily.
Remember that not all tracker funds are the same. Some will aim to track the FTSE 100, some will aim to track the FTSE allshare and others track a percentage of the aforementioned. Believe it or not a small handful of providers still charge up to 5.5% for fees to enter their trackers which must be close to Criminal given how little they do.
Some investors are of the view that trackers are lower risk but this is far from the case. They are simply tracking the UK stock market with no diversification into any other investment assets.
Furthermore the UK index can easily become overly exposed and if you held a tracker you could do nothing about that.
Take a tracker following the FTSE100 for example. In this column we told investors back in 2006 that banks were too expensive and heading for a fall. We also called the peak of oil price last year and told everyone to get out. Had you taken that advice you would be much more content than an investor in a tracker today.
If you had held a tracker you would have simply watched the index fall and your money with it. An active manager who knew what they were doing could easily have dumped their exposure to banks and other cyclical assets such as oil and mining.
Indeed a stock that plummets in value too much could disappear out of the index and the tracker would then have to sell it. If that was the case the stock may fall from grace for some time until it began to perform more profitably. Unfortunately for you the investor, you will catch it no-where near the bottom and will only start to benefit from its gain when it re-enters the FTSE100 again. Puzzling thought process to wait until it's more expensive before you buy!
Notwithstanding that, many funds that are so called 'actively managed' are far from that. In most cases you are paying for a manager to buy stocks and hold them for long periods of time as opposed to your expectation which would simply be to maximise return and minimise risk.
You may also be surprised to know that many funds are designed not to make the best returns and minimise risk but simply to outperform the 'benchmark' of other funds in their sector. So their motivation if the funds are falling is not to stop the capital falling but to fall less than the rest. Splendid!
An exchange traded fund (ETF) is typically a more favourable option than a tracker in any event and in most cases is cheaper. The introduction of ETFs was probably the biggest pressure on price for trackers which had the monopoly on 'cheap' funds. An ETF is simply an investment into the price movement of a basket of stocks and has the ability for you to buy exactly what you want exposed to in a cost effective way.
Finally, be careful when building your portfolio. I studied the active management sector last week. The best fund had returned just over 40% over the five years, the worst had fallen over 21% and the average had returned 10.27%. Not every fund is the same. The best fund was also over 130% less risky than the worst!! Choosing the best funds is an art and skill.
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