Index tracker fund FAQs
Here we seek to address some frequently asked questions about index tracker funds.
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- What is a tracker fund?
An index tracker fund (also known as a passive fund) aims to track the performance of a particular index; such as the FTSE 100 or the FTSE All Share. They offer a convenient way to gain exposure to a broad range of shares or bonds at a low cost.
- What is an index?
An index is a basket of shares that represents the performance of a stock market. So, for example, the FTSE 100 contains the largest 100 companies listed on the UK stock market. Most major markets have indices that can be used to track their performance, for example the S&P500 in the US. Normally these indices are run by an independent company who sets the rules on what is included and what proportion of the index each company represents. Often the biggest, most widely traded companies are the biggest holdings in the index.
- What areas do they cover?
Tracker funds are available which invest in companies listed in most markets around the world. They are normally broken down by country or region, for example US Equities or Emerging Market Equity. There are also bond trackers, which hold bonds issued by governments or companies. You can find more information about the funds and the indices they track here.
- How can I find a tracker fund covering a certain area?
Tracker funds cover most major markets, but there are some areas which are not covered. This may be because the area is niche or companies would be costly to invest in (like the AIM market). Other passive investments, such as ETFs, cover a wider range of investments. You can find more information about the funds and the indices they track here.
How they work
- Can I take income from a tracker fund?
Yes. Most tracker funds come as either income or accumulation units. With income units, income is paid out to fund holders as cash. This could provide the investor with an income stream or the cash could be reinvested to buy additional units. With accumulation units income is retained within the fund and reinvested, increasing the price of the units. Generally, for investors who wish to reinvest income, accumulation units offer a more convenient and cost-effective way of doing so.
- How are the investments managed?
The job of the tracker fund is to follow the index and the manager will normally do this by buying the investments in the index, in the same proportions as the index. However the fund manager has some discretion over this process and may decide not to invest in certain holdings, for example if he feels that a company would be costly to buy whilst adding little to the fund's performance.
- What is the difference between full and partial replication?
A fully replicated tracker fund holds all the shares or bonds in its index. By using partial replication, a tracker fund aims to deliver the performance of the index without the cost of owning every single stock in the index. Full replication is more common in indices with a smaller number of holdings, or in bigger funds which have the scope to invest in a larger number of shares.
- If the index goes up by 10%, will my fund grow by 10%?
Not necessarily. Indices are often quoted without dividends whereas the tracker fund performance normally includes dividends. Tracker funds have management charges which are not incorporated in the index performance. Finally, the index performance is normally worked out as the performance at the close of market on a particular day, whereas most tracker funds are valued at midday. Over the long term, the fund performance should be very similar to that of the index, but in the short run they can deviate.
- What is stock lending?
Some managers can lend the stock held by the fund to a third party in exchange for a fee. Tracker funds are ideally suited to this because there is often low turnover of their investments. In exchange for lending stock, the fund receives a fee which can help to offset some of the fund's management charges, reducing costs.
At all times the fund remains the beneficial owner of the shares - it is entitled to all dividends and has the right to recall the stock at any stage. The fund is normally given collateral (often cash or a different stock) to hold whist the stock is on loan, but there is a chance that the fund could lose money if the loan can't be recovered. While the risk is very low, cautious investors may prefer to invest in funds which do not lend stock.
- How often can I buy or sell my fund - is there a minimum investment period?
There is no minimum period, but you can only buy or sell your tracker fund at its daily valuation point. Unlike shares which trade continuously during market hours, funds usually only value once a day. Dealing instructions have to be received before the valuation point so you will never know the price at which you will buy or sell a fund.
- Can I hold tracker funds in my SIPP or ISA?
Yes. Tracker funds can be used in an ISA, as part of a SIPP or they can be held as standalone investments.
- What does it cost to buy and sell tracker funds?
Often funds have an initial charge, which could be up to 5.25%. Many brokers, including Hargreaves Lansdown, have negotiated savings on these charges. In most cases, you will pay no initial charge to buy a tracker fund through the Vantage Service. For some funds - primarily Vanguard's tracker funds - the fund manager has set a dilution levy which is applied when the fund is bought or sold. This dilution levy covers the manager's costs when placing investments and cannot be discounted.
- What does it cost to hold tracker funds?
Tracker funds have annual charges which are calculated and deducted from the fund on a daily basis. In some cases Hargreaves Lansdown has negotiated substantially lower charges for these funds.
There is also a charge to hold the fund on the Vantage service - which is no more than 0.45% p.a. of the value of your fund.
Looking for a ready made fund portfolio?
Our Tracker Portfolios are three portfolios designed to appeal to investors with different attitudes to risk. They're not advice but they will give you ideas to help you start investing.