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Updated: May 17, 2023, 4:01pm
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Index tracker funds are a popular form of investment that offer investors exposure to a wide variety of shares, often at a relatively low cost.
In the FAQs below, we explain how tracker funds work and why they are popular with investors.
Tracker funds have similar aims, but not all versions are the same. Some are cheaper than others, for example, and differences exist amongst funds in terms of their ability to replicate accurately the performance of certain stock indices.
We’ve asked Laith Khalaf, head of investment analysis at stockbroker and investing platform AJ Bell, to identify five index trackers suitable for would-be retail investors. In other words, the likes of you and me.
Below are his selections (in alphabetical order) and the methodology behind his fund choices.
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- Featured Partners
- Fidelity Index World
- iShares Core FTSE 100 ETF
- iShares Core MSCI EM IMI ETF
- iShares Physical Gold ETC
- iShares MSCI World SRI ETF
- Methodology
- What is an index tracker fund?
- How do index trackers work?
- Index funds, ETFs and stocks: what’s the difference?
- How do I buy an index tracker fund?
- Frequently Asked Questions (FAQs)
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Fidelity Index World
Fund size
£4.9 billion
(April 2023)
Fund type
Open-ended investment company (OEIC)
Target index
MSCI World Index
Fund size
£4.9 billion
(April 2023)
Fund type
Open-ended investment company (OEIC)
Target index
MSCI World Index
Key points
- MSCI World Index is a benchmark for global funds of all shapes and sizes. The index covers large and medium-sized companies across 23 developed markets. Investors’ cash in this Fidelity fund will flow into over 1,500 stocks across the globe
- In common with most stock indices, MSCI World is weighted by the size of the companies in the markets it tracks
- Given the huge success and high share prices of companies such as Apple, Alphabet and Microsoft, a lot of this fund is held in the US market (currently over two-thirds)
- These so-called Silicon Valley tech titans trade at quite lofty valuations adding a risk to investors by being exposed to such a large slice of the US market.
- On the flipside, the US stock market has gone from strength to strength of late. Similar performance in the future is not guaranteed, though.
Annual fund charge
0.12% per annum
Who should invest?
Index tracking or ‘passive’ investing is all about low cost and simplicity. The Fidelity Index World fund offers both. A good option for investors who simply want exposure to global markets but don’t want to spend a lot of time picking a fund.
Methodology
When evaluating index-tracking investments, AJ Bell’s head of investment analysis, Laith Khalaf, highlights two main areas of consideration. “We consider whether a fund in question is effectively tracking its benchmark index and also look at the annual fund charge which plays such a crucial part in tracker fund returns”.
What is an index tracker fund?
Index tracker funds – also known as ‘index’, ‘tracker’, or ‘passive’ funds – are a type of ‘pooled’ or ‘collective’ investment scheme.
A pooled arrangement aggregates sums of money from lots of different people into one large fund allowing it to be managed on their behalf by a professional investment management firm.
Index trackers aim to replicate the performance of a certain stock market index, such as the UK’s FTSE 100, or the in the US.
As an investor in a tracker fund, you can only (at best) expect to mimic the performance of a particular index. It’s important to remember that the money you invest in a tracker will, over time, follow the movements of an index – both down as well as up.
Index tracking is in contrast to so-called ‘actively managed’ funds run by professionals who pick specific stocks in order to beat an underlying index.
Index tracker funds come in a variety of guises. As well as those that track particular stock market indices, products may also focus solely on a specific industry or sector (such as technology or healthcare), countries, or particular investing styles (such as ESG).
How do index trackers work?
When you put money into an index tracker fund, the cash is used to invest in all the companies that make up a particular index. This provides the investors with a more diverse portfolio compared with buying, say, just a concentrated handful of stocks.
Index tracker funds aim to mirror a specific index as closely as possible and they try to do this in one of two ways.
The first method is by a process known as ‘full replication’, which essentially means buying all the components of a particular index. For example, in the case of a FTSE 100 tracker, a tracker fund will buy shares in all 100 companies within the FTSE 100 index in proportion to the size of each company as it appears within the index.
The second process is called ‘partial replication’. Rather than buy all the shares in an index, tracker funds in this camp invest in a representative sample of companies that feature on a particular index.
Index funds, ETFs and stocks: what’s the difference?
Stocks are units of ownership in an individual company, rather than a portfolio of assets as with funds and ETFs, and are traded using live prices.
Index funds and ETFs share similar characteristics as they are both ‘passively-managed’ and aim to track or replicate an index. However, their different legal structures affect the way in which they’re bought and sold.
Index funds are ‘open-ended’ investment vehicles as there’s a potentially limitless supply of shares or units. These funds are ‘forward-priced’ meaning that they are priced once a day and investors do not know the execution price until after the transaction has been placed.
Whereas ETFs are ‘baskets’ of securities whose shares are traded on an exchange, meaning that investors can buy and sell ETFs in real-time using live prices.
How do I buy an index tracker fund?
You can buy direct from a fund provider, or purchase holdings via an online investing platform, trading app, stocks and shares ISA provider or through a financial advisor.
Frequently Asked Questions (FAQs)
Why bother with index trackers?
Passive funds form a significant part of the global investment landscape. The reason for this is because statistics have shown that actively managed portfolios frequently fail to beat their benchmarks and often charge higher fees than passive funds.
According to research from AJ Bell, only a third of active equity funds managed to beat their passive alternatives in 2021. The company’s ‘Manager versus Machine’ report said that active outperformance last year was particularly sparse in the US, Global and Asia Pacific regions.
What is tracking error?
One way to weigh up the performance of a passive investment fund is to consider its tracking error. This reflects how much a tracker fund’s performance deviates from the index or other benchmark it’s meant to be tracking.
Tracking error is measured as a percentage, so a tracking error of 0% indicates perfect replication. A tracking error that is just the cost of the fund (see below) would reflect a passive investment that is doing its job exactly as it should.
How much do index tracker funds cost?
Passive funds tend to be cheaper than their actively managed counterparts.
The reason for this is because, regardless of whether your index tracker relies on full or partial replication, the fund ought to cost less to administer overall than it would if it employed a team of active managers.
The tracker funds identified above feature charges ranging between 0.07% and 0.2%. A £1,000 investment in the latter, therefore, would cost £2 although, depending on where the fund was bought (see below) additional administrative/dealing charges may also apply.
In contrast, the fee for an actively managed fund might typically range between 0.5% and 1.5%.
What is an exchange-traded fund?
There are two main types of tracker funds: exchange-traded funds (ETFs) – which are tradeable on the stock market – and open-ended investment companies (OEICs) – which aren’t.
ETFs are a form of passive, collective investment that tracks entire stock market indices, specific sectors, currencies or commodities. OEICs, meanwhile, embrace a wider range of pooled or collective funds, some of which are trackers.
Unlike OEICs, ETFs can be bought and sold in the same way as ordinary shares. Deciding between ETF or OEIC may depend on how much your broker charges for holding each type of product.
What is an exchange traded commodity?
Exchange traded commodities (ETCs) are similar to ETFs, but these are investment vehicles designed to track the performance of an underlying commodity index, such as gold or oil.
Can I lose all my money in an index tracker fund?
Any kind of stock market-based investing incorporates a risk of some kind. An index fund that owns dozens, if not hundreds, of shares is better diversified than a portfolio that holds just a handful of companies.
In the example of a stock index fund, each company would have to fail before investors lost everything. That said, depending on its focus, an index fund could underperform and lose money for several years if, say, a sector or investment region fell out of favour.
Are index funds better than stocks?
That depends on the risk appetite of the individual investor. Stocks are a higher-risk option due to the risk of an individual company underperforming, or in the worst case, ceasing to trade. However, stocks may deliver higher potential returns.
By comparison, index funds provide a ready-made diversified portfolio of assets for investors. If one company or asset underperforms, this may be offset by another asset outperforming, meaning that investors receive the average return over all of the assets.
However, some index funds may be higher risk than individual stocks. For example, commodity prices may be more volatile than the prices of the large-cap companies in the FTSE 100 index. The risk profile will depend on the underlying assets invested in by the index funds.
It’s also worth bearing in mind that the fees can vary between index funds and stocks. Most, but not all, platforms charge a share trading fee for buying and selling stocks and ETFs, whereas many charge a lower, or no, fee for buying funds.
However, platform fees may be charged for holding funds, whereas these tend to be lower, or sometimes capped at a fixed amount per year, for stocks and ETFs.
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- How To Buy Stocks
- Best Lifetime ISA
- Best Robo-Advisors
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Andrew MichaelEditor
Associate Editor at Forbes Advisor UK, Andrew Michael is a multiple award-winning financial journalist and editor with a special interest in investment and the stock market. His work has appeared in numerous titles including the Financial Times, The Times, the Mail on Sunday and Shares magazine. Find him on Twitter @moneyandmedia.
