Top 10 index trackers

by Jane Baker on 14 March 2010  |  8 comments
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Fancy taking the plunge into the stock market with an index tracker? Here’s everything you need to know.

Are you looking to boost your SIPP or invest in a stocks & shares ISA? At lovemoney.com we reckon an index tracker should be your first port of call. Why? Because it’s a cheap and easy way to get exposure to shares without having to pick stocks yourself.

Index tracking is a very simple investment strategy which involves investing in all the company shares quoted on a particular index with the aim of replicating how the index performs.

So, for example, if you put your money in a FTSE 100 index tracking fund, you would be investing in the all the top 100 UK companies. Your investment will then closely match the performance of that index. If the FTSE rose by 10%, your investment would step up by around 10% too. Of course, the reverse would also be true when the FTSE falls.

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Which tracker should you choose?

You can buy trackers which track indices in the UK and globally. But I think first-time investors should probably stick to the UK as these trackers will cover the market you’ll be most familiar with.

Most UK tracker funds track the FTSE 100, the FTSE 250 or the FTSE All Share index. Remember a FTSE 100 tracker - which invests in the 100 largest UK firms and covers over 80% of the UK market - will perform completely differently from one which invests in say, the FTSE 250 which consists of the next 250 largest companies. By comparison the FTSE 250 covers just 15% of the UK market, and is therefore a far more concentrated investment than a FTSE 100 tracker.

Meanwhile, the FTSE All Share index is an aggregation of the FTSE 100, the FTSE 250 and the FTSE Small Cap indices, and represents over 98% of the UK market. If you want investment exposure to virtually the whole of the UK stock market, an All Share tracker would be the best choice for you.

Once you’ve decided which type of tracker to go for, it’s important you choose the specific fund(s) to invest in wisely. The table below should help which shows how the top ten performing UK trackers have done over the last five years and, even more importantly, outlines the charges:

Top 10 UK trackers

Source: Trustnet. Figures as at 09.03.10. *TER is 0.27% for accumulation version of the fund and 0.35% for the income version.

Past performance isn’t as important for trackers as it is for actively managed investment funds. After all, the objective of a tracker is to match the performance of the index it’s based on as closely as possible, and therefore funds which invest in the same index should perform in the same way.

But you’ll see from the table that this isn’t always strictly true. For example, the top performing All Share tracker - the Halifax UK FTSE All Share Index Tracker fund - has returned 37.1% over the past five years, while the AXA UK Tracker has only returned 31.3% over the same period.

You’ll also see that the returns from each fund don’t exactly match the index they’re tracking either. The difference in the returns happens for two reasons: firstly the charges - or the total expense ratio, TER - and secondly the tracking error.

TERs and tracking errors

Tracker funds aren’t actively managed because the shares you’ll invest in are determined by the companies which make it onto the index, rather than being selected by a team of stock picking experts. This means they should be a lot cheaper than funds which employ active fund managers.

This is one of the major benefits of trackers. Active fund managers regularly make the wrong calls and underperform the market as a result. But trackers will always produce returns which closely match the index while being significantly less costly for investors.

For this reason you should be wary of trackers which charge over the odds. Any fund which has a TER of 1% or more is very expensive, particularly when you see that the cheapest funds on the market - the HSBC FTSE 250 Index fund, the Fidelity Moneybuilder UK Index and the F&C FTSE All Share Tracker - all have a TER of less than 0.3%. 

There’s really no excuse for high charges when it comes to trackers because you aren’t getting anything extra for your money. Make sure you avoid these rip-offs.  

Finally, the tracking error measures how closely a fund tracks the index. Quite simply, there are different tracking strategies, some of which are more successful than others. This also explains why the returns aren’t identical for trackers which are following the same index.

Is there a downside?

Perhaps the biggest problem is that trackers are unable to react to changes in the market. If the prospects for a particular sector become a concern, an active fund manager could divest the shares likely to be affected. But a tracker fund must plough on regardless even if that means the returns could be forced down.

Having said that, I still think trackers offer investors good value for money given that the top funds are usually inexpensive and often beat actively managed funds.

If you're new to investing you may have one or two questions. Why not ask the lovemoney.com community what they think using our excellent Q&A tool?

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