What is a tracker?
Firstly, it is an investment fund - this could be a unit trust or an open-ended investment company (OEIC). Equity investment funds hold shares in a large number of companies, and anyone can then buy units or holdings of that fund. What distinguishes it as a tracker is that the fund manager tries to make the fund mirror the movements of a particular stock market index - say the FTSE 100. So all trackers must be the same... No - for a start, they don't all follow the same index. Some are more successful at sticking to the index, and some are more expensive.
What's the best index for a tracker to track?
A UK index tracker might follow the FTSE All-Share index or the FTSE 100, and some track the FTSE 250. The All-Share covers most of the UK stock market index, the FTSE 100 only takes in the 100 largest companies.
The pros and cons of each vary, depending on the stock-market.
How do active funds work?
Active funds are the opposite of trackers. An active fund manager uses his
or her investment skills to achieve even higher returns than a particular index or accepted benchmark. This means analysing research on companies and the economy, and hoping to pick those stocks which perform better than average.
What are the best things about a tracker?
It's easy to understand and you're not relying on the skills of one individual. Passive funds tend to achieve better performance than most active fund managers, according to many studies. Analysis by the WM Company shows that the majority of actively managed trusts underperformed the FTSE All- Share Index over the last decade.
Why choose an actively managed fund?
You may believe a particular fund manager is capable of outperforming passive funds. Some, though not many, actively managed trusts do outperform the index in the long-term, The WM Company says. But their study highlights how hard it can be to pick a good fund, showing that even if a fund is in the top 25 per cent in performance tables in a five-year period, there is only a random chance it will repeat that in the next. "Not only do very few managers beat the index, but it's almost impossible to identify in advance those that do," says Rowan Gormley, chief executive of tracker provider Virgin Direct.
Any other reasons?
Trackers tend to perform well in certain investment sectors, but there are
others where they don't. "Looking at the US, there's a powerful argument for a tracker," says Rob Fisher of HSBC Asset Management. Less than 15 per cent of actively managed US funds outperformed the index in the last quarter of 1998. But this is not necessarily the case for investment in Europe or Japan, for example.
Are trackers safer than other PEPs?
No. This is a myth. A tracker follows an index on its way up, but also has to follow it back down. When the market is falling, active funds often do better than trackers, their advocates say. In periods of volatility, active managers can shelter investors by holding fewer equities and more bonds, cash and gilts. But an actively managed fund could become heavily exposed to one particular company which its manager believed was a rising star. If he or she were wrong, that large holding could seriously dent the entire fund.
Why is our Government approving them, then?
It's not approving them, exactly. But trackers do win the Treasury's CAT benchmark for Individual Savings Accounts. This means that purely in terms of cost, accessibility and terms, this type of fund meets the standard laid down.
The Independent has published a 28-page guide to PEPs by Nic Cicutti, sponsored by Scottish Widows Fund Management. For a copy of the guide, call 0345 678910