How do tracker share funds work?
Last week I looked at managed share funds and why they don’t work. Put simply, the ‘experts‘ who dip into and out of the market on your behalf, often aren’t very good at it… and the huge charges they levy on every transaction soon eat up any profits you do make.
So why DO so many financial advisers push managed funds? Well there’s more money in managing investment funds for one thing. Admittedly it’s the fund managers making the real cash, charging you for all those transactions they make, as they pursue their investment in pension funds – usually around 1.5% for a managed fund against upwards of 0.1% for a tracker. And who is buying those shares on your behalf? The problem is that with multi-manager investment funds you don’t really know who’s picking the shares in your fund. But that means their commission on a managed fund is likely to be higher than that on a tracker. Turkeys tend not to vote for Christmas, and somebody selling you a fund isn’t going to vote for tracker funds.
So what do we do? We buy a tracker. You can significantly cut the commissions you pay by buying and holding rather then buying and selling frequently. Put simply, fewer trades, fewer commission payments to your broker.
You also put off paying tax on your profits if you defer selling, allowing more of your money to stay in the market for longer, thereby taking advantage of compound interest. The trackers emerged in the 1990s as many investors began to question the conventional wisdom – that ace investors could beat the market. The new idea was that in the increasingly efficient stock markets of the West, all the information about companies was out in the public domain. It was hard to find bargains … so why bother?
Simply buy the FTSE All Share index, for example. Confident in the knowledge that it would grow 8% or more a year. Buying the index can mean doing exactly that – buying every share in the index, in varying proportions of course. Other funds will be more complex, buying a cross-section of companies that together will still track the index. But however it’s done, there is no dipping into and out of the market depending on good or bad news. Costs are kept low therefore, and no subjective judgements are made.
So do they work? The evidence over the last decade or so is a qualified yes. In ‘bull‘ markets, the tracker will surf the tide of universally rising shares. Bear markets are more of a problem, with trackers following the market down. And when the index has a high proportion of banking shares, as indexes tend to do, then a hit to the banking sector can hit the fund hard.
AND, as you’ll realise, the world banking sector is not in the greatest shape right now. An active manager would argue that he could duck out of banking shares at that point — though as we saw last week, active funds simply don’t have the success rate to back that up. Some experts also claim that trackers increasingly distort the index, as more and more money piles into the big companies, rather than looking for new, growth stocks.
Is that a problem? It CAN exaggerate the scale of crashes when they come, with investor money continuing to pile into stocks that are heading for a fall. A worldwide tracker right now might be giving you more exposure to the arguably overvalued Chinese stockmarket than is sensible … and we DID mention those banking stocks. And if active funds were avoiding those pitfalls, we might agree, but they tend not to.
The irony is, that many of the big financial institutions, who eagerly flog managed funds to the small investor, are actually putting THEIR money into trackers. THEY don’t want to take risks. I’d say the main choice is which tracker you go for. And that, seeing as you AREN’T buying any expertise, WILL BE the cheapest. They start at around 0.1% and that’s how much you should be paying. Of course, unit trust prices and the rest, go down as well as up, regardless of the tracker success story – so you must be prepared for down times.
You’ll find a good selection at Hargreaves Lansdowne, which is one of the UK’s biggest brokers and which also offers reliably good value and service in my experience. Still not convinced? You’re perhaps thinking of ace stock pickers such as Warren Buffet, Benjamin Graham and Britain’s own Jim Slater. I’d also caution that these guys probably had a little more time to study the markets. But if you DO want to go it alone … I’ll be looking at how you can complement your index tracker by selecting your own value shares in another article soon.
Tags: track share funds, managing investment funds, investment funds, trackers, tracker funds, personal financial advice