Trackers keep their investors' funds fully invested in shares at all times, so there may be more downside potential than you'd get with an actively-managed fund run by a human stock-picker. He or she has the option to sell a few shares and hold some of the fund as cash. But the advice for tracker fund investors, as it is for all stock market investors, is to sit tight if you can afford it - historically, markets will come up again, and if you sell up now, you could miss out on any bounceback in share prices.
There are 28 index-tracking unit trusts on offer, most of them available as a PEP. But not all trackers perform alike, and if there are dark days ahead, some of these funds will stand up better than others.
Don't expect your tracker fund to match the index printed in the daily papers: "The ironic thing is that you will always underperform the index by the amount of charges the funds make, plus expenses such as trustees and audit costs," says Alan Gadd, managing director of HSBC's investment funds. That's because the FT-SE 100 or All Share index isn't calculated to take any buying and selling costs into account. There are some easy ways to spot a winning tracker, though: "The bigger the fund and the fuller the replication, the tighter the tracking of the index."
Full replication means that the manager buys every share included in the index. FT-SE 100 tracker funds can easily do it, but Virgin is the only fund which fully replicates the 848-strong All Share index. Alan Gadd believes its performance can only get stronger, as the pounds 1.2bn fund gets bigger. Tracking is one area of investment where giant funds really are better - it keeps the costs to investors down.
One of the main arguments against trackers is that some actively managed funds perform far better than the index, so by buying a tracker you may only be getting mediocre returns when someone else has hit the jackpot. That's true, but it's impossible to predict which funds will do well in future. Even a big name with a good reputation offers no guarantees. Schroders has had a miserable time recently. Three of its flagship UK funds have under-performed the All-Share for the last two years.
Quite apart from the risk that your chosen fund may not shine, the extra charges you have to pay in an actively managed unit trust - generally 5-6 per cent is taken out of your investment at the start, and then 1- 2 per cent every year after that - mean that it is an expensive gamble. It may not be worth taking the risk if you are an investor who only buys UK funds and chooses not to keep a close eye on investments. Just under half (48 per cent) of all UK unit trusts beat their respective indices in the year to 30 June 1998.
Active management has a crucial role to play for many investors. Although index tracking is one useful tool in the more mature and efficient stock markets, like the UK, you should pay someone else to pick foreign shares. HSBC's Alan Gadd says: "If you are investing in Asia and Japan you will do better with an active fund because they are inefficient markets. The best Japanese funds are underweight in large financials - it's relatively easy for fund managers to out-perform the index."
Figures cover three years to 1/9/98. Bid to bid, net income reinvested
Company % change
FT-SE All Share 56.45
Dresdner RCM 55.08
Norwich Union 52.17
Old Mutual 52.12
Source: Micropal S&P