Tracker Funds - Overview

Many people quite reasonably decide that actively managing their investments is too complex for them and wish to delegate this task to the experts.

The wise then try and become informed and very often end up concluding that the best solution for them is a tracker, a passively managed fund that just buys the shares that make up an index such as the FTSE 100.

This sounds unambitious and boring and surely an expert buying and selling only certain shares will do better?

The trouble is that the answer will generally be no, it is sort of beyond belief that there is this massive financial services industry but the best thing to do is almost nothing.

A great example of this can be seen if you type "Buffett and Protege bet" into a search engine.

The basic argument is that you can always find a fund manager doing really well, but over a longer period and all investments actively managed funds nearly always fail to outperform the market as a whole.

Tracker Funds - The "But"

The big, big but that advocates of "put your money into a FTSE 100 tracker" ignore is that they look solely at percentages and are unconcerned by the amount of money that represents.

The sales pitch goes along the lines of "Mrs Bloggs bought a tracker 20 years ago and she is living off the dividends and her fund is growing faster than inflation."

Oh by the way Mrs Bloggs started her tracker fund off with just £2 million!

If you are starting of with say £10,000 you will be getting the same percentage growth as Mrs Bloggs, but her 10% is £200,000 and your 10% is £1,000.

Does it even need saying that most people wouldn't spend £200,000 a year but couldn't live on £1,000?

Of course what your needs are are irrelevant if the market cannot generate them and if it can then why are the people who run the trackers not doing this "thing"?

Tracker Funds - How Is The Money Spent?

A tracker fund will normally buy all the shares in an index, but it will not simply say there are 100 companies in the FTSE 100 index and you have £100 so it will invest £1 in each company.

Instead it might say company 1 is worth twice company 2 so the tracker will by twice as many shares in company 1.

If you had a FTSE 100 tracker this would mean that roughly half of your money would be invested in about 12 companies (May 2019), the other half in the remaining 88 companies.

This weighting brings some undesirable side effects, such as the biggest companies tend to be in a few market sectors, Oil and Pharmaceuticals.

So if you imagined that your tracker gave you a diverse portfolio of 100 companies the reality could be 20% in oil and 20% in drugs.

Recognising this risk there are the so called "Smart Trackers" that use various strategies to remove market sector and company size weighting.

Once you do this it is no longer just a tracker and the weighting may result in significantly better or worse performance than a simple tracker.

Tracker Funds - The Costs

Trackers tend to be low cost as they can be operated automatically and the market for them is reasonably competitive.

The only issue is that it can be difficult in practical terms to work out what these fees will be as there are different way of presenting them, but generally expect them to be in the range of 0.2% to 1%.

Note in big bold letters that this is 1% of the investment not 1% of the profit.

If you are fortunate enough to have a significant investment then it is worth checking if there is an upper limit on fees, such as the fees will never be more than £200 per year.

Whilst the fee doesn't sound much, it is payable each year regardless of a growth or losses in the fund value, so in a year with minimal or no share price growth a 1% fee could easily be 25% of the dividend income.

It is inherent in a tracker that it must occasionally buy and sell shares, these transactions will incur dealing fees and stamp duty. Usually these fees are absorbed by the fund meaning that the tracker will always grow slow slower than the index it is tracking.

Tracker Funds - Risks

Although the FTSE 100 tends to go up over the long term there are periods with little or negative growth.

Even during periods of little growth or losses;
  • You will still be paying your management fees

  • Companies will be leaving and joining the index meaning that shares will have to be sold, potentially at a loss and bought possibly at a premium to their true value.

In a rising market the operating costs are relatively easily absorbed, in a stagnant or falling market fund management and trading costs and losses can start a serious decline in a funds value even if the index remains at a fairly constant value.

Tracker Funds - Some Real World Numbers

Period 1 - The FTSE 100 started the year 2000 at around 6,100 and on the 18th April 2019 is at 7,437, this is a growth of 21% over 19 years.

Period 2 - The FTSE 100 on the 6th April 1984 was at 1,096 and at year 2000 was around 6,100, this is a growth of 450% over 14 years.

During period 1 you would have lost out heavily to inflation in terms of your capital, most of your dividends would be needed to offset this loss.

Period 2 is much nicer, but is it repeatable?

So again we see what was highlighted and repeated in the short term holding section, what works for an institutional investor who has a long term view may be problematic for a private investor with a fixed date for retirement and needing the results of a successful investment.