DIY investors turn to trackers for a more ‘passive’ approach
STAYING AS close as possible to a published and recognisable index has immediate appeal to both borrower for loan and investor for savings. Often referred to as the ‘passive’ approach, financial tracking has become enormously popular in recent decades.
The pioneer was John Bogle, who died aged 89 last year. He lived long enough to see his enterprise materialise, no doubt following Scottish poet James Thomson’s lines in 1863: “As we rush, as we rush...Come flying on our track.”
Two Chicago University students suggested a fund which would track an index in 1960 and an institutional one was launched in 1972 but Bogle created the inaugural one for retail investors in 1975.
The First Index Investment Trust was its initial name but later changed to Vanguard 500 Index as it followed Standard & Poor’s list of the top 500 US quoted companies.
Today, Vanguard has over US$6.2 trillion under management, making it the major provider of mutual funds and second largest (after BlackRock iShares) for exchange traded funds (ETF) which are low-cost trackers but structured like shares. In the UK, trackers now account for 18 per cent of funds.
For savings, the aim of a tracker is to hold securities in the same proportion as in an index. An alternative approach is to use statistical sampling to hold representative securities. In either case, a key point to check is how far a fund deviates from the published model.
There is a variation where ‘enhanced’ trackers provide index-like exposure but accentuate certain sectors. Fees are slightly higher than simple trackers.
“With most actively-managed funds failing to outperform their respective benchmark, it is no wonder the DIY investor has turned to passive and cheaper sources,” says Saul Fulda, analyst at Redmayne Bentley.
Savers have taken to trackers not only to obtain an entire range of companies and thereby not miss an opportunity but because of the far lower charges.
A collective run by a stockpicking manager, backed up by a team of researchers, typically costs 0.88 per cent, which is over three times the average passive fund at 0.24 per cent and can fall as low as 0.06 per cent.
In both cases, the platform fee is extra.
Larger passive funds should be able to not only replicate more fully but their economies of scale should cut charges.
Some fields really need a tracker. Myron Jobson of Leedsregistered Interactive Investor says: “It is difficult to make small investments in bonds (but the funds) need to have enough capital to amply track the chosen index.”
He gives iShares JP Morgan $ EM Bond ETF as an example of gaining exposure to around 500 bonds across both government and corporate sources and with an annual 0.5 per cent fee.
Both bricks and mortar and precious metal are specialist fields available as trackers. Martin Payne, senior investment manager at Brewin Dolphin in Leeds, suggests iShares UK Property, an ETF with 39 listed real estate companies with full replication, and iShares Physical Gold, an exchange traded commodity. The ongoing fees are 0.4 and 0.19 per cent respectively.
Take care as to which index is selected as some can be very concentrated. The FTSE 100 has around 55 per cent by value across five sectors and 25 per cent invested in just five stocks. The S&P 500 is even more pronounced with over half in just three areas and 27 per cent of the index in 10 companies. Diversification may be the aim but not the result.
Fees between trackers can differ enormously. The annual charge for the iShares UK Equity Index varies from 0.01 per cent (class X) to 0.51 per cent (class A). Jason Hollands from Tilney advises anyone who invested in a tracker five or more years ago to check they are in the cheapest fund.
Among still expensive ones are Halifax UK FTSE All-Share ‘C’ at 1.03 per cent, Halifax UK FTSE 100 ‘C’ 1.05 per cent, Scottish Widows UK ‘A’ one per cent and Virgin UK Index 0.6 per cent.
“Some of the biggest rip-offs in the tracker world are in zombie Child Trust Funds where UK trackers can cost a whopping 1.5 per cent, but badged as valuefor-money stakeholder option,” reveals Hollands.
He suggests parents in Legal & General’s (N) Tracker CTF, which has £200m assets, and charges 1.5 per cent, switch to a Bestinvest Junior ISA and cut their costs by two-thirds: 0.4 per cent plus Fidelity UK Index ‘P’ Fund (0.06 per cent).
Some managed funds have been revealed to be closet trackers. Last year Janus Henderson was fined £1.9m for overcharging thousands of investors who were paying high fees to collectives that were essentially tracking indices.
Tracking can also apply to loans, notably mortgages. This is where the provider follows the Bank of England base rate and then adds a flat fee.
Investment tracking provides enormous choice. Dow Jones alone offers 130,000 indices but it depends which ones a provider wishes to follow.
ETFs are quoted on the stock market which means they are easy to trade. They are priced continuously through the day whilst tracker funds are generally purchased through fund management groups with dealing once a day.
Ian Forrest, at The Share Centre, likes iShares FTSE 100 where the major holdings include HSBC, AstraZeneca, Royal Dutch Shell and BP.
The fund has a tiny expense of 0.07 per cent and a distribution yield around 5.8 per cent.
“It is one of the larger funds with assets over £7bn and has tracked the index well,” says Forrest.
Vanguard FTSE All-World ETF is his other tip. The fund has 4,000 large to mediumsized firms from developed and emerging markets.
As it pays income quarterly, it appeals to those seeking regular income with a yield of almost two per cent. This ETF has a low tracking error and costs just 0.22 per cent.
Payne warns that trackers can offer geared/leveraged returns using derivatives rather than physical assets suitable only to those with higher levels of risk tolerance.
This introduces counterparty risk and could make the investment useless.
Darius McDermott, from Chelsea Financial Services, prefers active funds over passive as the latter are never going to outperform the market they are following and will achieve market performance minus charges.
“You can’t just copy an index to outperform it,” says Darius.
McDermott adds a tracker is “effectively buying yesterday’s winners”. They are not necessarily the companies growing the most. Investors are also forced to hold sectors and stocks that are falling: technology in 2000, banks in 2008 and oil earlier this year.
He likes trackers in specialist areas where there is no active alternative and in large US companies where selection is difficult.
In the thematic sector, Alasdair Pike at wealth manager J.M. Finn likes Legal & General Cyber Security ETF as it is a an area difficult to replicate owing to its diversity and rapidly changing nature. However, in tracking terms, it is not cheap at 0.75 per cent.