There is often a wonderful argument delivered by the different sides in relation to the argument 'do I invest in a tracker fund or a fund that is actively managed?'

Those last two words will catch most of you out as you will of course be believing that your pension funds, endowments and bonds are all actively managed on a day to day basis. You would be mistaken – badly.

By and large most of the larger managed funds simply spread their capital across a wide range of sectors and then let it 'ferment'. Easy money for them, but surprisingly for me, many investors are highly apathetic to the poor performance. It is only really after a period of constant under-performance that investors indeed decide to hold their adviser to task.

But what is a tracker and how useful are they?

The idea of a tracker was initially to reduce cost by simply allowing your fund to follow a given stock market index as opposed to having a fund manager trying to beat it, but failing.

Of course the PR companies of either side regularly come up with arguments in their little minds that I could easily hit with a nine iron but both have a point.

It's not that difficult to look at a graph of 'actively managed' fund managers to see that most are just large expensive clumpy tracker funds with the speed and agility of the Titanic – three years after it sank. Their fees are extortionate for their under performance but they are probably perversely aware that their brand lets them get away with it.

However, some managers add value on a day to day basis and if you analyse this in consistent small periods of time rather than a snap shot at a high/low point in their history, you will see the number adding consistent value is a small one, but it exists. That said, a good quality investment adviser will have the processes in place to pick the very best. However, if you are considering a tracker fund you might just need to do a bit of homework as all is not what it seems.

There are two main types of trackers: Full replication and, wait for it, stratified sampling. Great eh? Full replication means your tracker will do everything it can to track a given index e.g. the FTSE 100, by buying, where possible, the same stocks in a similar weighting to that of the actual index itself.

Stratified sampling isn’t as sexy as it sounds, it's just over complicated, but I'll explain. This version of a tracker holds the biggest shares of the index plus a sample of the other leading shares from that sector. So, where an index might hold twelve pharmaceutical stocks, the stratified sampling version (I can't believe I am even typing that) might hold the top five or six pharmaceutical stocks.

If I am trying to decide who is the best tracker I simply analyse those tracker funds that are big enough to cope and study how much they track the index and how much they differ from it. Then I simply look at the charges, as all else is secondary with a tracker.

It really is hard to imagine why a tracker fund could actually charge more than a 1% annual total expense ratio, and in fact, you might expect this to be closer to 0.5% than 1% whereas an actively managed fund could be over 2%.

A total expense ratio (TER) is simply a measure of the total annual costs of running a fund and includes the costs for other services paid for by the fund, such as the fees paid to the trustee (or depositary), custodian, auditors and registrar.

Some TER's are c0.3% and are a very attractive way to access the market but be careful as they don’t all do what they say on the tin.

For a free fact sheet on the top tracker funds call call peter on 0845 230 9876, e-mail or take a look at our website

The value of shares and investments can go down as well as up


(1) Sesame

Peter McGahan is an Independent Financial Adviser and the Managing Director of Worldwide Financial Planning Ltd who are authorised and regulated by the Financial Services Authority. 'The FSA does not regulate Credit Cards, Will Writing and some forms of mortgage and Inheritance Tax Planning.'

Information given is for general guidance only, and specific advice should be taken before acting on any suggestions made.
The above represents the personal opinions of Peter McGahan.
All information is based on our understanding of current tax practices, which are subject to change.
The value of shares and investments can go down as well as up.

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