Low-risk speculators find they're on the wrong track

The poor stock market debut and subsequent performance of Bradford & Bingley shares over the past two weeks are partly due to the fact that the bank is too small to get into the FTSE 100.

The poor stock market debut and subsequent performance of Bradford & Bingley shares over the past two weeks are partly due to the fact that the bank is too small to get into the FTSE 100.

This means it hasn't been snapped up by tracker funds - passive investments that track an index, as opposed to a fund manager picking stocks. Trackers are popular with investors because they are cheaper, seen as lower risk, and produce returns at least as good as actively managed funds but without the volatility. The bad news for investors in trackers is that their returns have been hit hard by the recent stock market turbulence, proving that they are not immune to share-price volatility after all.

"They are a simple choice, not a safe choice," says Steve Lipper, global marketing director at Lipper. "People feel that investing in their home market through a tracker is less risky than investing across borders. But this is purely an emotional assumption.

"A global equity fund that extends to other countries ends up being a much more stable ride than a single-country fund. I would say to someone investing for the first time to go for a global equity fund. If you already have one and want to increase your UK exposure, a UK tracker fund is a decent choice for a second investment."

Trackers are perceived to be lower risk because they offer a low-cost means of diversification to limit exposure to under-performing shares. They enable individual investors to spread their money over a wider range of stocks than anyone but the largest investor could afford to buy directly.

Some trackers are more diversified than others because they follow a smaller index. Investors should bear in mind that FTSE 100 trackers, for example, comprise fewer and bigger companies - the top 100 blue-chip firms - than, say, FTSE All-Share trackers, which invest in more than 900 companies. Those who in-vested in the latter would have seen a 15 per cent return over the past two years, against 9 per cent in a FTSE 100 tracker, according to Datastream.

To make matters worse, because the composition of the FTSE 100 changes regularly, it does nothing for the stability of tracker funds that have to buy the various components. Earlier this month, five companies were ejected from the FTSE 100, including Bookham Technology, Baltimore Technologies and Sema Group, to be replaced by firms such as Rolls-Royce and Safeway.

The popularity of tracker funds has grown largely because they are cheaper than active funds, which typically charge up to 5 per cent in upfront fees along with an annual charge which tends to be about 1.5 per cent. Trackers are much cheaper as they have no upfront charges, while annual fees can be as little as 0.3 per cent.

So what should investors who relied on tracker funds to limit volatility do now? If you are determined to stick with trackers, it is worth opting for the ones with the lowest costs: with no stock-selection skills needed, these should do best.

Legal & General's UK Index tracker, which invests in the FTSE All-Share, is one of the top performers in its field because it has no entry charge and an annual management fee of just 0.5 per cent. L&G has about £2bn in retail tracker funds, with a further £40bn in institutional tracker funds. A spokesman says that while trackers can be risky, its UK fund spreads its exposure by following the FTSE All-Share. "Any form of investment carries a risk of one shape or form," he says. "The more stocks you buy, the more you diversify and reduce risk."

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