Index Trackers
“Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals.”
Warren E. Buffett, 28 February 1997
What is an index tracker?
An index tracking fund, as the name suggests, invests its assets in a way that aims to track the performance of a particular index.
This is achieved by holding some or all of the shares in that index in the same proportions that they themselves make up the index. So for example a FTSE 100 Index Tracker might aim to invest 10% of its funds in BP shares, if BP makes up 10% of the FTSE 100.
Holding the shares in this way means that if the FTSE 100 went up by 6% in a year, the index tracker should also go up by about 6% as the fund follows the performance of its index.
The fund manager therefore has no intention of making judgement calls as to which companies they think will do well in the future. They simply follow the index using automated systems that buy and sell shares when necessary.
For this reason index tracking is known as a form of passive investment management and is the reason why it can be seen as the less stressful way of holding equity investments.
Methods used by index tracking funds...
It's not always possible or efficient to hold all of the stocks or shares in a particular index. For this reason there are various methods that index tracking funds can employ to mirror the performance of an index:
Traditional index tracking - the practice of holding a representative proportion of the individual securities that make up an index. As those securities make up more or less of the index, or even fall in and out of the index, over time the proportion of those securities held within the fund are changed accordingly. This is perhaps the most passive form of index tracking.
Synthetic index tracking - this involves the use of equity index futures contracts and lower risk invetsments to mirror the performance of the index being tracked.
Enhanced index tracking - this refers to a variety of strategies that may be employed to actively replicate the performance of an index. This type of method can involve higher costs than traditional sampling.
Operating index tracking - this method involves measuring and comparing a company's financial performance and compiling a fund on the basis of comparable results to its peers.
Advantages of index tracking...
Because the systems to buy and sell shares within an index tracker are largely automated there is no need for expensive research or well-paid fund managers to make judgement calls on which shares to buy. The cost of investing in these trackers is therefore vastly reduced.
Initial charges are almost always 0%. Annual charges can be as low as 0.1%, compared to the average actively managed fund which has an annual management charge of 1.6-1.8% typically.
The stress of wondering how well your manager is doing once you have picked your ideal actively managed fund, or set of funds, compared to all the other funds you could have invested in is also a constant burden. Therefore passively managed index tracking funds are considered less stressful.
Because they simply aim to track the performance of an index they are also easy to understand and follow. Investors can simply keep an eye on their respective index e.g. FTSE All Share to have an idea as to how their fund is performing.
By holding a variety of index tracking funds an investor can put together a well diversified portfolio at very low cost.
How can I invest in an index tracker?
Our Instant Funds Portfolio offers access to many index tracking funds, all of which are available at no initial charge.
Our Free Range Portfolio offers access to all index trackers and exchange traded funds (ETFs), including exclusive access to the Vanguard range of index funds.
