A growing number of investors are refusing to hand over big chunks of their money to fund managers and are instead turning to lower-cost tracker funds.
Last Thursday, the Investment Association, which monitors how much people are investing and where, said private investors pulled a record £1bn from British funds in March.
But while the headlines concentrated on the huge outpouring of money from the UK, the figures also showed the highest ever inflow into tracker funds in one month. The total amount held in such funds smashed through the £100bn mark for the first time, and they now make up 11.5% of total funds under management, compared with 9.8% last March.
Often known as “passive” investments, tracker funds can be a good place to start for novice investors who want to keep charges to a minimum, but they increasingly make up the mainstay of many experienced investors’ portfolios. There are three main reasons investors opt for trackers, according to Sam Lees, head of research at FundExpert.co.uk: lower charges, easier investment choices and the belief that you can’t buy an active fund that consistently gives above-average performance.
Advisers often argue that active management can add value over and above any fees charged, particularly in volatile markets when managers can use their stock-picking skills to shield investors from potential losses. “As an investor, you do buy a bit of a blunt instrument when you buy a tracker, but it comes down to the type of investor you are and what you are comfortable with,” Lees says.
Do you lose out with a tracker?
There are only 116 tracker funds to choose from, compared with more than 2,000 actively managed funds. However, although actively managed funds supposedly offer the potential for higher returns than tracker funds, many fail to beat market indices.
Recent figures from Standard & Poor’s show that last year more than 80% of actively managed funds invested in US equities failed to beat the S&P 500 Index, a US stock market index based on the market capitalisations of 500 large companies. Over the same period in the UK, 55% of actively managed funds invested in UK equities underperformed the S&P UK Broad Market Index, which measures UK stock market performance.
“In some stock markets, such as the US, active managers have struggled to add value,” says Jason Hollands, managing director of Tilney Bestinvest. “Even Warren Buffet recently admitted that a low-cost S&P 500 Index tracker was a sensible way to invest in the US.”
But, he says, investors don’t need to take an either/or approach. “A passive-only approach is just as flawed as one that confines itself to actively managed funds.” Instead, he says, when choosing an active fund investors should be selective and consider whether history suggests that the fund manager has the skills to add real value.
How much will you pay?
Low costs are one of the most compelling reasons for investors to choose tracker funds, as charges can have a significant impact on overall returns.
According to research by Candid Financial Advice, £20,000 invested over 10 years with an annual return of 7% would grow to £38,977, assuming it was held in a tracker fund with charges of 0.1%. Assuming the same growth in an actively managed fund with charges of 1.6%, you’d be left with a return of £33,840, so you’d have paid £5,137 more in charges than with a tracker.
“Of course, this assumes fund performance is identical before charges, and in practice this will not be the case,” says Justin Modray of CFA. “Some active funds will perform better than trackers after charges, and some will perform worse.” But the comparison does highlight the importance of monitoring how much you pay.
“In most portfolios it makes sense to combine low-cost trackers with some good actively managed funds focusing on areas it is not possible to track – for example, physical property and absolute return, and active managers who invest very differently to the index,” Modray says.
Investors can easily get a tracker where ongoing charges are less than 0.2% a year. “Charges on trackers have dropped three times in the past nine months,” says Mark Dampier, head of investment at Hargreaves Lansdown. “I don’t see anywhere near these levels of cuts when it comes to active funds.”
What to choose
According to Modray, good, low-cost FTSE All Share Index tracker funds include the Vanguard FTSE UK All Share Index, which charges 0.08% a year, and Fidelity Index UK at 0.09% a year, or 0.07% when held via Fidelity’s own platform.
But remember, not all tracker funds have low charges. “Investors do need to keep an eye out on the cost of investing in passives,” Hollands says. For example, he says, there is a “staggering difference” in charges available between “legacy” trackers such as the Virgin UK Index Tracking fund, which has an ongoing charge of 1%, versus the low-cost UK index funds such as Fidelity Index UK.
For those interested in investing in Europe, Dampier suggests the Legal & General European Index, which tracks the performance of the FTSE World Europe (excluding the UK) Index. The ongoing charge is 0.12%. He also likes the BlackRock Corporate Bond Tracker and the BlackRock Japan Equity Tracker, both of which charge 0.17%. These charges are all discounted through Hargreaves Lansdown and a number of other investment platforms.
Scott Gallacher, of independent financial adviser Rowley Turton, says that the passive versus active debate is not the central issue for investors at all. “Most investment professionals are in agreement that by far the most important factor in investment success is simply consistent, long-term allocation to the right kinds of real assets, and that stock selection – or lack of it – is a secondary issue,” he says.
“For example, an investor who has the confidence to stick to their guns when stock markets are in seeming chaos, compared to those who panic and sell out in an attempt to protect their money, will almost always see much better long-term returns.”
‘Active funds are a con’
Mark Owens, 40, a finance director for a tech startup, has invested in tracker funds for the past 15 years because he doesn’t believe active funds are worth the extra cost.
Owens, left, who lives with his wife Sarah, 38, a local school bursar, and their eight-year-old son James, in Farnham, Surrey, says: “I have never held active funds because they are a con and their performance is often worse than passive tracker funds. I’ve seen no firm evidence to suggest they do any better than trackers, which cost considerably less.”
He invests in a number of tracker funds and exchange-traded funds (ETFs) through Tilney Bestinvest, both in Isas and his self-invested personal pension. ETFs track the performance of a particular market or index and are traded like individual stocks.
Owens holds funds including Fidelity Index UK, Vanguard US Equity Index and iShares S&P 500 UCITS ETF. He says: “I regularly review my portfolio to make sure I’m not overweight in any particular area. I tend to earn irregular chunks of income, so I pay occasional lump sums into the funds whenever I can. These are long-term investments and, so far, I’m pleased with how they have performed.”
