Introduction to Investment Funds – Tracker Funds Explained

This article aims to aid in the education of the novice investor by investigating Tracker Funds. The key features are presented alongside the influential risks and benefits of this form of investment fund.

What is a they?

A Tracker Fund is an investment fund which aims to replicate the performance of, and achieve the same returns as, a specific market or index. They do this by investing in all or a representative selection of the companies listed in that index.

They work to match, or "track", the performance of any of a number of worldwide stock market indices (such as the FTSE 100 Index) and are not actively managed by a fund manager. As a result, Tracker Funds are a form of passive investing.

Put simply; Tracker funds are investment funds that simply track a stock market index to match its overall financial returns. The value of the can go down as well as up, so you may get back less than you invested.

Benefits

Due to the fact that Tracker Funds are a form of passive investing they require less management commitment and as such incur lower costs. For example, whereas active funds have annual charges of 1.25-1.75 per cent, trackers have annual charges of 0.5-1 per cent.

They also offer investors with an investment approach that is simpler and easier to understand than many of the alternatives. This is because once an investor knows the target index of the fund, the specific securities that that Tracker Fund will hold can be determined directly.

Also, because index funds are passive investments, the turnovers, i.e the costs for selling and buying of securities by the fund manager, are lower than actively managed funds

Risks

The principal risk or disadvantage with a Tracker Fund is that it cannot outperform the target index. As explained above, a Tracker Fund by definition aims to match rather than outperform the target index. Therefore, even a well-managed Tracker Fund will not generally outperform the index, but rather produce a rate of return similar to the index minus fund costs.

It must also be understood that over the last decade Tracker Funds have followed declines in indexes without the ability to take defensive positions. This is because Tracker Funds become representative of the overall index or market performance and so, if the whole index suffers a decline, then so does the fund and it cannot act to rectify this by only matching the well-performing stocks within a particular index.