7IM is reducing the costs of its AAP passive multi-manager funds by replacing some of the exchanged-traded funds and tracker fund holdings with direct exposure to the underlying shares.
The firm feels it is important to keep costs down in the current climate of low growth to prevent charges eating into investors’ capital. It says the average annual cost of a passive investment is 0.25 per cent but buying a basket of shares to track index performance brings the total expense ratio to zero.
7IM chief Tom Sheridan says the AAP funds needed to be of a sufficient size to make the basket of shares approach possible, with the technology in place to keep the baskets up to date. He says shares cannot be bought and ignored as price movements could result in a stock being 4 per cent of the index one day and 4.1 per cent the next.
Sheridan says there is a trade-off between the number of stocks bought to track an index and tracking error, which is the amount by which a portfolio deviates from the index. He says that the more stocks you buy, the less the tracking error.
7IM will buy all 100 stocks on the FTSE 100 but would not buy all 500 stocks on the S&P 500 because the bigger companies make up a bigger proportion of the index, so holding fewer smaller companies would not have much of an impact in terms of tracking error.