Tracker funds offer a convenient and low-cost way to gain exposure to a broad range of shares or bonds. They aim to track the performance of a particular market index, such as the FTSE 100 in the UK or S&P 500 in the US.
Tracker funds are ‘passively’ managed, as they simply aim to replicate the make-up of the index they are tracking. This is in contrast to an ‘actively-managed’ fund, when the manager will typically select just a few investments from the index with the aim of beating the index return over the long-term.
Tracker funds can be a great way to get started, quickly invest in a particular country or region, or form the building blocks of a portfolio. Other investments, including actively-managed funds, can be added with the aim of boosting returns, generating a higher income, or reducing risk, depending on your objectives.
So, what should you consider when thinking about an investment in a tracker fund?
The most important consideration is which index to track, and whether this meets your objectives. We generally feel broader, more diversified indices are better and have wider appeal.
An investor who seeks passive exposure to the UK stock market, for example, has three options.
- FTSE 100 – the largest 100 companies in the UK
- FTSE 250 – the next 250 largest companies (medium-sized businesses, or ‘mid-caps’)
- FTSE All Share – includes all those above plus around 300 smaller companies
The FTSE 100 is perhaps the best-known of these, but the index tends to be dominated by multi-national companies whose fortunes are not really tied to the UK economy. Indeed, around three quarters of the revenue earned by FTSE 100 companies comes from overseas.
The FTSE All Share in contrast is a much broader index. It provides exposure to companies of all sizes and across a broad range of industries. It is arguably a better barometer for the UK economy and is more likely to be considered by investors who specifically seek exposure to UK-focused companies.
The choice of index is arguably more important for overseas markets, where investors are likely to be less familiar with the index options available. In the Asia Pacific region, for instance, the FTSE AW Developed Asia ex. Japan Index provides exposure to Australia, Hong Kong, New Zealand and Singapore. The FTSE World Asia Pacific ex. Japan Index provides exposure to Korea, Malaysia, Taiwan and Thailand, in addition to the four countries mentioned previously. We feel the latter index is therefore a better choice for investors seeking broad exposure to the Asia Pacific region.
Almost as important as the choice of index are the fund’s charges. Costs are often the biggest factor in determining tracker fund performance. Over time costs gradually reduce a fund’s performance and the higher the costs the greater the drag will be.
Over longer time periods higher charges have an increasing impact. This is why we have negotiated hard with fund managers to obtain the lowest possible charges for our clients on some of our favourite tracker funds.
Even though the managers of tracker funds are not making active decisions to invest in some stocks and exclude others, they each construct their funds in slightly different ways. It is therefore beneficial, in our view, to consider a range of tracker fund providers and select the best one in each area.
In addition to the index and the charges, the main considerations from this point of view are the method used to replicate the index, and if the manager engages in stock lending.
- Replication – full replication is when the manager holds all the shares or bonds in the index, whereas partial replication is when the fund chooses not to hold some smaller stocks. Partial replication is common where the index being tracked has a large number of constituents. We generally feel that full replication is best for investors, as it leads to more precise tracking, but recognise that this is unfeasible in some markets.
- Stock lending – this is the process where a fund lends its holdings to a third party in exchange for a fee. Stock lending is a useful tool for managers to offset costs, but it does carry some risk. We are comfortable with a fund lending stock only if investors benefit from lower fees and the manager takes steps to control the risks.
Our favourite tracker funds
The index a fund aims to track, its charges, and details of the replication method and approach to stock lending are available on our website. However, we have also aimed to take much of the hard work out of selecting a tracker fund by highlighting our favourites on the Wealth 150+. The Wealth 150+ Trackers all go through a rigorous research process that considers all of the above. Our analysis also aims to identify which funds have tracked their index closely in the past and, importantly, are well-placed to track accurately in future.
Below I have highlighted what we believe are the best tracker funds for exposure to all the major global stock markets and bond markets. In addition to the annual fund charge the Vantage charge of up to 0.45% per annum also applies.
Asia Pacific & Emerging Markets
- BlackRock Pacific ex. Japan Equity Tracker – we rate this fund for its relatively broad approach, low fees, and a track record of tracking its benchmark tightly. There is exposure to developed markets such as Australia and Singapore, and higher-risk emerging markets such as Thailand and Malaysia. Given its growing importance on the world stage we are positive on the long-term growth prospects of the Asia Pacific region.
BlackRock Pacific ex. Japan Equity Tracker KIID
- BlackRock Emerging Markets Equity Tracker – the size and complexity of emerging markets means it is one area where partial-replication is more practical. BlackRock have a good track record in this area and this is our favourite option for passive exposure to some of the world’s fastest-growing and higher-risk economies.
BlackRock Emerging Markets Equity Tracker KIID
Corporate & Government Bonds
- BlackRock Corporate Bond Tracker – this fund tracks an index which contains over 1,000 corporate bonds. It uses partial replication, which is more cost-effective, but is still well-diversified. Corporate bonds have performed well in recent years and the yields available are not as attractive as they were. That said, they can still play a part in a balanced portfolio.
BlackRock Corporate Bond Tracker KIID
- Legal & General All Stocks Gilt Index Trust – gilt yields are at very low levels so charges are arguably even more important. This fund is available for an annual charge of just 0.1%. Legal & General have managed gilt funds for a long time and they fully replicate the index so any tracking error has been kept to a minimum.
Legal & General All Stocks Gilt Index Trust KIID
- Legal & General All Stocks Index Linked Gilt Index Trust – low costs and full replication means the fund has generally tracked the index tightly. Index-linked gilts have performed well in recent years, but investors should note they are prone to significant volatility as their performance is more influenced by interest rate expectations than by inflation, at least over shorter periods.
Legal & General All Stocks Index Linked Gilt Index Trust KIID
- Legal & General Global Inflation Linked Bond – the global inflation-linked bond market is too large to hold every bond so the fund is partially replicated. The fund only launched in 2013 but we believe it is a good way to access inflation-linked bonds globally. The low annual fund charge is a further positive.
Legal & General Global Inflation Linked Bond KIID
- Legal & General European Index – this fund fully replicates the FTSE World Europe ex. UK Index for an annual charge of just 0.09%. It has tended to track tightly and we are currently positive on the long-term prospects for the European market which looks undervalued, according to our analysis. Unsurprisingly, the largest exposures are to France and Germany, but the fund also has investments in Belgium, Finland and Norway.
Legal & General European Index KIID
- Legal & General International Index Trust – this fund offers a simple way to gain broad exposure to developed stock markets across the globe (excluding the UK). Almost 60% is invested in the US, which is the world’s largest stock market by far. The fund offers exposure to over 2,300 companies for an annual charge of 0.08%.
Legal & General International Index Trust KIID
- BlackRock Japan Equity Tracker – Japan is often dismissed by investors, but we believe the stock market is undervalued and prospects are good. This fund holds every stock in the FTSE Japan Index, which gives exposure to over 450 companies and offers the potential to track tightly, in our view. Costs are low at just 0.11% a year.
BlackRock Japan Equity Tracker KIID
- Legal & General US Index – the US stock market has performed exceptionally well since the financial crisis and is by no means cheap, according to our analysis. However, it is a big call to omit the world’s largest and most important stock market from a portfolio entirely. The US is home to international household names and plenty of innovative companies with the potential to revolutionise entire industries. This fund fully replicates the FTSE USA Index, a broad benchmark of over 600 US companies, for just 0.06% a year.
Legal & General US Index KIID
- Legal & General UK 100 Index – the biggest blue-chip companies on the UK stock market comprise the FTSE 100 Index. It is not the most diversified index, but it is home to many companies that are incredibly successful on the international stage. This fund fully replicates the index at a low cost and we have been encouraged by performance.
Legal & General UK 100 Index KIID
- HSBC FTSE 250 Index – medium-sized companies can offer the dual advantage of being small enough to offer excellent growth potential, but large enough to have established and robust business models. UK medium-sized companies performed poorly after last year’s Brexit vote as they tend to be more reliant on the UK economy than larger counterparts, but they have since bounced back strongly. HSBC is an experienced manager of passive funds and this fund is fully replicated with low costs.
HSBC FTSE 250 Index KIID
- Legal & General UK Index – this fund fully replicates the FTSE All Share Index. Its simplicity and low costs – an annual fund charge of just 0.06% - means we feel it is the highest-quality FTSE All Share tracker fund available, and an excellent option for consideration for broad exposure to the entire UK stock market.
Legal & General UK Index KIID
This article and our Wealth 150+ tracker funds are not personal advice. If you are unsure of the suitability of any investment for your circumstances please contact us for advice. All investments can fall as well as rise in value so you could get back less than you invest.