Who needs gunslingers to win the great stock market shoot-out?

No one has been measuring up index-tracking funds for a coffin this year, says Jenne Mannion. Their investment returns have left stock-pickers eating dust
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The Independent Online

In industry parlance, these "gunslingers" hunt successful companies, the performance of which, they hope, will "shoot the lights out".

But, in the first half of this year, history has been turned on its head.

From the start of 2005 to 17 June, the average tracker fund in the UK All Companies sector delivered a return of 7.1 per cent, according to figures from fund-statistics provider Lipper.

This handsomely beat the 6.3 per cent return scored by the average "actively managed" fund in the same sector, of some 900 companies.

A glance at the recent performance of the stock market reveals why: in early January, the benchmark FTSE 100 index was hovering around the 4,800 mark. On Friday, nudging 5,161, it reached a three-year high.

The recent success of both the index and tracker funds is down to robust performance from some of the UK's biggest companies - the dominant players on stock market indices, says Paul Ilott of independent financial adviser (IFA) Bates Investment Services.

For example, healthy profits have recently been recorded at household names such as HSBC, Vodafone and BP.

This is important since trackers follow a basket of shares in which an individual company's weighting will depend on its market capitalisation. Your money is not spread evenly across each share; more is invested in the bigger companies.

"The top 10 largest groups - including GlaxoSmithKline and HSBC - make up 43 per cent of the FTSE All Share index [by value]," says Mr Ilott.

In 1994, the top 10 companies made up barely a quarter (23 per cent). "Today," he adds, "index returns are far more reliant on performance from the biggest stocks than [in] the early 1990s."

Healthier balance sheets in many larger businesses have also allowed a number of them to either return cash to shareholders (in the form of dividends), or to invest to grow. This increased capacity for expansion has led to mergers and acquisitions - an activity that generally helps to prop up share prices.

And indications that the Bank of England might cut interest rates sooner rather than later have also encouraged investors, as this could restore flagging consumer demand.

The past six months have put the value of tracker funds back in the spotlight. Cheap to run, they usually don't levy an upfront fee and carry low annual management charges (AMC) of 0.5 to 1 per cent.

Compare this to active equity funds. These have an upfront charge of as much as 5.5 per cent of your cash just to "buy in", and sport a much higher AMC of around 1.5 per cent.

But, so the theory goes, these higher costs are there to pay for the fund manager's skill in picking stocks that will make you a juicy profit.

There are, however, flaws to this theory: many managers make poor share choices, while others do little more than "hug" or copy a particular stock market index, despite being paid to find gains elsewhere.

Many IFAs - who, it is also worth noting, make less commission from tracker funds - believe that paying for a manager who at least tries to find extra returns is better than committing your cash to a fund that will simply bob around according to the market's rise and fall.

Given the economic conditions, they argue, it is unlikely we will see a repeat of the strong growth in the 1980s and 1990s, when the annual gain on the stock markets regularly reached 12 per cent.

A tracker will do nothing more than "chase a return that reflects average performance", says Mr Ilott, and so an active manager is a better bet.

Although the average tracker has outperformed the average actively managed fund, there are 300 active funds in the UK All Companies sector, points out Justin Modray of IFA Bestinvest. "The performance of the weak," he explains, "has dragged down the better ones."

In fact, many stock-picking funds have gone great guns and beaten both the average tracker and average actively managed portfolio, he stresses. Premier UK Opportunities has returned 12.9 per cent, while New Star Hidden Value is up 10.11 per cent.

If you do want to invest in a tracker, check the charges first - expect to pay no more than 0.5 per cent, warns Mr Modray.

Yet Virgin's FTSE All-Share index tracker charges double, with an AMC of 1 per cent.

"Investors in this fund who want [to keep] a tracker [in their portfolio] should certainly switch," says Mr Modray.

Tracker funds from Legal & General, M&G and F&C all charge a lower AMC.

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