Personal Finance: How do trackers work?

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The Independent Online
L&G AND Virgin are the big players and each has more than pounds 1bn in its index trackers. They use very different methods to replicate the performance of the index - and it's worth knowing about this before you invest.

Virgin buys all the shares in the index, in the correct proportions. This is called "full replication". The managers trade every 10 days or so. The make-up of the portfolio is rebalanced to match the index every time buying takes place.

This full replication costs more: Virgin's fund charges are 1 per cent a year. L&G's is just 0.5 per cent a year.

L&G uses a technique called "stratified sampling". This is the most widely- used method of reproducing the All Share index, and the theory is that the top 400-odd shares are bought in full, which gives full replication of around 90 per cent of the value of the All Share.

The rest of the shares are chosen according to sector; the overall fund represents the exact proportions of each sector (financials, pharmaceuticals, etc) as they appear within the All Share index.

The manager may decide, for example, to buy extra "weight" in engineering sector, and will simply buy shares in the biggest engineering firm which falls outside the top 400 companies, and perhaps one or two others - working from the top downward.

Critics say this isn't real index tracking as there is room for human judgement. The advantage of a big fund like L&G is that it finds it viable to buy many more shares than most other funds which use sampling: L&G now holds 783 of the 848 companies on the All-Share.

Contacts: L&G, 0500 116622; Virgin, 0345 900900