Index trackers beat most funds but there are times when it makes sense to search for something more specialised.
At the Motley Fool, we've long pointed out that index trackers are a much better bet than the typical managed investment fund. And, time and again, research backs us up. Not only are fund managers' stock-picking skills decidedly variable, making it difficult for them to beat the market in the long term, but the fees and charges associated with such funds tend to sap the gains that they do make.
This is particularly true of the big UK equity growth and UK equity income funds. Why pay someone up to 5% of your initial investment, and up to 1.5% each year thereafter, simply to invest in Britain’s hundred or so largest companies? Low-cost trackers buy much the same shares -- usually without the upfront cost, and generally for a much lower annual fee.
Keep your costs low
Legal & General's flagship UK Index FTSE All-Share tracker, for instance, charges just 0.52%. And many observers expect tracker charges to go even lower. That's because the US fund group Vanguard, which manages almost £700b of investors' money, announced earlier this year that it will be launching a range of funds in the UK. Founded by investment guru John Bogle, Vanguard launched the world's first index tracker in 1976, and has a reputation for charging ultra-low fees.
Yet despite all the arguments in favour of trackers, there are circumstances in which the canny investor willingly pay the fees charged by managed funds -- especially if they have faith in the fund manager's stock-picking prowess.
Index trackers -- by definition -- track specific indices. The FTSE All-Share, the FTSE 100, and the FTSE 250, for example. Over in the US, Vanguard's flagship fund is the Vanguard 500, which follows the S&P 500 index, one of the main measures of the US stock market.
Investing in specialist areas
But what index trackers don't do is invest in companies in specific sectors of those indices, such as mining, technology, or oil. Nor do they invest specifically in companies that meet specific investment criteria -- faster-than-average growth, for example, or a good track record in paying a high level of dividend. Nor, with the odd exception, do they invest in overseas stock markets, such as those in India, China or Brazil. There are exchange traded funds that do track some more obscure investment fancies but they don't yet cover everything you might want to put money into.
So if you do want exposure to those opportunities, a managed investment fund is worth considering. Instead of picking individual mining, oil or technology companies, for example, you're effectively paying a fund manager to do the work for you -- and then buying into the basket of such companies that the fund manager has chosen. Likewise companies in overseas stock markets, or companies poised for rapid growth.
The argument for managed funds becomes even more compelling when those funds invest assets other than company shares. Trackers, by definition, follow the markets. Up. And down. Managed funds investing in corporate bonds, government gilts and property alongside company shares offer a useful element of diversification -- at a price, of course.
And it's also worth noting that it's also possible to buy into funds that invest solely in such assets. So if you want a proportion of your portfolio in government gilts or investment grade bonds, a specialist managed fund, investing only in that asset class, is one way of achieving that.
In short, while trackers are usually a much better way of buying a diversified basket of company shares, managed investment funds do have their place.
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Malcolm Wheatley's delightful wife Mandy has Legal & General’s UK Index tracker in both her ISA and SIPP.
