Tracker funds are designed to follow the market. This passive style of fund management does not aim to outperform – although this is possible depending on allocation weightings – so investors should never expect to beat the market.
So why has interest in passive shot up? The funds, in particular trackers and ETFs, are becoming increasingly popular with investors fed up with paying high prices for funds that don’t deliver the returns they are looking for.
And analysts predict trackers will continue to rise in popularity, especially since the RDR implementation, as the downward pressure on active fund charges continues. Tracker funds are traditionally cheap – a key factor in why so many advisers prefer to choose them for their clients and model portfolios.
Passive investment fans argue that active management is riskier and that passive funds are more likely to at least match the market. However, critics disagree as passive funds can only ever beat the markets and indices if they are managed with a large tracking error – the measure of how closely the fund matches the performance of the index it tracks. While a high tracking error can boost returns, the manager would not be truly tracking the market and returns could also end up below the index.
Despite this booming popularity, the number of trackers is still much smaller than that of active. Tracker funds’ overall share of total funds under management is currently 8.7 per cent, according to the Investment Management Association (IMA).
However, this figure is the highest on record and has been increasing for years – it was 7.4 per cent in 2011. Net retail sales of tracker funds hit £1.5bn in 2012, well down from 2011’s record sales of £2.1bn. It did, however, register its place as third highest annual sales ever recorded. There are now 88 tracker funds, according to the IMA, and funds under management for trackers reached £57.4bn at the end of 2012.
Monkey business?
Research from Cass Business School recently suggested that equity indices constructed randomly by ‘monkeys’ would have produced higher risk-adjusted returns than an equivalent market cap-weighted index over the past 40 years.
The study’s researchers created 10m ‘monkey fund managers’ through computers to randomly pick and weight each of the 1,000 stocks, in much the same way a tracker fund is created, over each of the 40 years of the study. The results showed nearly every one of the monkey managers beat the performance of the market cap-weighted index.
So if monkeys can do it, why should investors be choosing trackers instead of going it alone?
Cost versus performance
