Index tracker funds that are failing investors

A number of tracker funds are completely failing to measure up to the index they are tracking, wasting investors' money in the process, according to a new report.

Index tracker funds should closely follow a specified index - the FTSE 100 for example - with the aim of reproducing that market's overall return, minus fees.

But a study by financial adviser and broker Chelsea Financial Services (CFS) has identified five tracker funds that have lagged behind their respective market indices by more than 4% in the last three years. That's a significant difference.

These failures include one fund that has come up short by a whopping 9% since 2012. Investors with £5,000 in this particular fund have lost £450 to a combination of excessive fund fees and tracking error. In total, these five straggler funds contain £2.55 billion of investors' money that would be much better off elsewhere.

Let's take a look at these underperformers:

Source: Chelsea Financial Services, data as at 1 May 2015

As you can see, each of these funds has underperformed its particular index by between 4% and 9% a year. In other words, over three years, these funds have fallen short by 1.3% to 3% a year, on average. That's far too much to lose, especially in this era of low interest rates and falling investment income.

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It's all about the fees

[SPOTLIGHT]In total, Chelsea Financial Services' latest RedZone report found 20 trackers that, since 2012, have failed to beat both their benchmarks and the average actively managed UK fund. Together, these funds contain £19.77 billion of investors' money. In other words, more than one in five (22%) of the 116 trackers available to UK investors have fallen short of their market benchmarks.

Given the design of index-tracking funds, some underperformance is bound to happen, but why have the five funds in the above table done so badly? The obvious and glaring answer is that they all have excessive fund fees that gobble up too big a slice of investors' overall returns.

With competition to attract assets at fever pitch among tracker funds, it's possible to buy into low-cost index trackers with fees as low as 0.07% a year. Anyone paying more than 0.4% or so a year to track major markets is being taken for a ride.

Here is the ongoing charge figure (OCF) for each of these five underperforming tracker funds:

Each of these tracker funds offers exceptionally poor value for money, simply because of their sky-high fees.

The cheapest charges fees just short of 1% a year, which still is five to 10 times more than the cheapest trackers following the same benchmark. 

However, the wooden spoon must surely go to investors in the L&G (A&L) Capital Growth fund, who pay an ongoing charge of 1.43% a year, plus they lose 3% of their cash on day one to a ridiculous initial charge. For a tracker fund, these charges are nothing short of scandalous.

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Loyalty is for dogs: move your money

If you have money gathering dust in a serially underperforming tracker fund, it's high time you waved goodbye to high fees and reduced returns. By moving your money to one of the lowest-charging trackers, you could increase your yearly returns by, say, 1% or more. This may not sound like a lot, but small improvements add up to big results over time.

For example, a fund producing 8% a year after all fees will return a profit of 366% over 20 years. Over the same two decades, a fund returning 7% a year will produce a gain of 287%. Which pot would you rather have, all other things being equal?

Be sure to read Top cheap index trackers.

Invest in tracker funds via a Stocks & Shares ISA