Tracker Funds and Exchanged Traded Funds (ETFs) are both passive types of investment vehicles that enable you to profit from the positive movement of a particular index. But there’s often hundreds of these around, so here we look at how you can pick the best.
Both are Passive and Great for Easy, Low-Cost Diversification
By Passive we do mean that they essentially ‘put their feet up’ and look to ensure that their performance of the fund matches a specific index rather than beat it (as an Active investment would try to do – and doesn’t always manage to even match it!).
They do this generally via buying all the associated shares of a particular index (such as the FTSE 100) or taking a representative sample sometimes of whatever index they are tracking. ETFs can take this a step further by using ‘swaps’ or ‘derivatives’ whereby they don’t actually own the underlying assets. We’d suggest staying away from the latter type – also called ‘synthetic’ replication as opposed to ‘physical’ replication’.
The beauty of both is that they have very low charges associated with them – for example they tend to be in the region of 0.1% in comparison to the 0.5%+ applied by active funds.
Funds of this nature are a great way to diversify your portfolio without having to worry about too much about the underlying investments. If your chosen index or indices rise, then you profit! It’s that simple.
Differences better Tracker Funds and ETFs
Tracker Funds essentially come in ‘two’ types – these are just the usual fund structures of an Open Ended Investment Company or a Unit Trust. The difference you will notice here is that they are priced once per day only unlike ETFs.
ETFs are listed investments which means you will get a live price whenever you want to buy or sell. So that’s the first big difference.
The second main difference is that ETFs can give you exposure to a wider variety of investments with greater risk and greater reward.
However, you should pay close attention to the way that ETFs hold their assets – some will use a ‘physical’ replication approach which means it will hold whatever investments it say it does as per the fund factsheet. However some will use ‘synthetic’ replication’ which means it does not hold the underlying assets – this is why they can also give you access to a wider selection of more risky and illiquid investment opportunities.
Thirdly, ETFs also tend tend to be even cheaper to invest in rather than Tracker Funds.
Picking Tracker Funds & ETFs: Some Handy Tips
So you’ve made the decision to invest passively, now comes the time to pick a Tracker Fund or ETF to invest in. And as you may expect, you’ll be spoilt for choice – the same index can often have 10+ competing ETFs or Tracker Funds! So here’s some tips to help you get to pick the best passive investment for you:
- Decide on your index: FTSE 100, FTSE 250, FTSE All-Share, Euro Stoxx 50 (Europe) even the S&P 500 (US). That’s the first step. Some other common areas including Emerging Markets, Corporate Bonds and Property.
- Use third party research: Some Online Platforms will highlight what they believe to be the best Tracker Funds as part of their ‘Best Buy’ lists. Other third party websites will also provide their own ratings. They are worth checking out to give some ideas. But always do your own research!
- Understand the legal structure: Tracker Funds will usually be either OEICs or Unit Truts, Exchange Traded Funds will be just that.
- Note the type of ETF: ETFs will either hold all the assets to track an index (physical full replication), some of the assets on a representative basis (physical sample replication) or not directly hold the assets (synthetic – more risky).
- Note if it offers an Accumulation or Income option: Accumulation will auto-reinvest the dividends whereas an Income option will provide you with the income directly.
- Underlying index: Look out for confirmation of the underlying Index that is being tracked such as the FTSE 100 in the UK or NASDAQ 100 in the US (with lots of technology stocks exposure).
- Ongoing Charges Figure: These are usually way cheaper than active funds but can still vary (say from 0.1% or lower to 0.5% or higher).
- Performance! Believe it or not, despite Tracker Funds looking to track, their returns can vary (slightly – we’re talking small %’s not like huge variations between active funds).
Lets’s get Physical! Just like Picking an Active Fund but Less Difficult…
The two main considerations when picking Tracker Funds are deciding on what index or indices you want exposure to and what type of structure you want to use (a Tracker Fund Vs ETF).
ETFs have their benefits in that they can be even cheaper than a Tracker Fund (Unit Trust or OEIC structure) and you know the price at any point in the day. However, with ETFs it’s important to ensure that you look out for Synthetic replication as this adds a layer of risk that is not necessary for the average investor.