Are tracker funds the most efficient solution to making money or is it just noise, noise, noise?
Our financial industry seems to design its thousands of arguments to ensure you are either invested, or you are invested. It’s the same as the argument about using either shampoo for greasy hair, or using shampoo for dry hair: whichever you choose, you still do the worst thing for your hair – put shampoo in it.
Tracker funds are believed to be a cheap way to access the FTSE 100 or any other index for that matter. Keen to save cash, the investor believes tracker funds to be the best solution as they can save on the annual policy charge. Most actively managed funds have an annual management charge of c2%, yet a tracker can be available for less than 0.5%. The question is whether or not the actively managed fund can really add value over the tracker fund and make that extra charge work.
So let’s look at what tracker funds do. A tracker fund charges for a computer to simply track the stock market. Easy money if you can get it. The FTSE100 is the top one hundred companies listed on the London stock exchange. ‘Top’ is measured as their market capitalisation i.e. their total amount of shares multiplied by their share price.
They aren’t just UK companies and the FTSE isn’t representative of the UK stock market or the UK economy, because much of the business completed within these organisations is global.
And so if you track an index you track the share price of these global organisations.
The top ten companies by capitalization currently contain five mining, oil and gas exploration organisations. (1) If that sector has a downturn, the FTSE nosedives. Over time, different sectors of the stock market perform well and vice versa.
The key is to move in and out of them at the right time. For example, in 2000 technology was all the rage, yet Vodaphone is now the only tech company in the top ten of the FTSE100.(1) Banks were the rage for a while, yet only HSBC is now in the top ten.
Mining and oil has done well but what happens with an inevitable slowdown in the expansion plans of China, which will be sooner than most think?
Tracker funds will replicate the FTSE 100 by moving companies in and out as the FTSE100 moves them in and out e.g. TUI Travel was replaced by Tate and Lyle in June.
Therefore consider the impact on your capital. As a company falls you will have to watch it plummet through the FTSE100 and out of the index and your capital will fall with it. As a sector of the market falls you will simply give back all the gains you have made and you can do nothing about it as the tracker chooses the company.
And so, as one company leaves the index the other replaces it, but only because its value is higher than the other. This can easily create a see-saw effect where the value of the FTSE100 stays level as each sector has its boom and bust and moves in and out of the market.
For example, the FTSE100 is still below its value in 1999, meaning you would have tracked sideways for 12 years. Moreover, in four of the last eleven years the FTSE fell by -6.5%, -14.7,-23.4 and -30.9. (2) The key is in managing the money effectively and efficiently whilst paying a fair price for that investment.
For example, the Marks and Spencers brand might lead you to believe you are buying quality. In last year’s rising market, those funds with £275m invested into it would indeed have gained 14.9%, and over the last five years they would have gained 14.5%. (3) (4) Compare that to the average active managed fund in the sector of 18.9% and 20.1% meaning that those invested into Marks and Spencers tracker fund – the UK 100 companies fund would have underperformed by £11million and £15.4m. And it’s far from the worst.
So be careful what you buy.
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