Experts say advisers and clients need to look beyond the recent tracker price war to establish which trackers are best at following the relevant index.
Passive investment jumped 50 per cent in the past year, according to Hargreaves Lansdown, while the average cost of a FTSE All Share unit trust or Oeic from the larger fund houses has fallen to about 16 basis points.
According to FE Analytics, the best performing tracker over the three years to 25 June is the £1.414bn Vanguard UK Equity Index, which returned an annualised 10.73 per cent, just 7 basis points under the index.
SWIP Foundation Growth came up worst. The £1.1bn Oeic undershot the index on average by 1.38 per cent each year. Annualised tracking errors for most of the retail trackers of the FTSE All Share are between 5.66 per cent and 6.72 per cent.
Vanguard and Aviva’s tracker had annualised tracking errors of 4bps and 75bps respectively. The £774m Aviva Investors UK Index had the lowest downside risk of 16.24 per cent – 20bps less than the FTSE All Share.
Morningstar OBSR director of passive funds research Hortense Bioy says tracking error figures are difficult to create and harder to rely on, as many funds are priced at different times than the index.
“It is a very sensitive measure and sometimes it can be difficult to calculate.
“Instead, I would look at the tracking difference: the difference in annualised returns between the funds and the index.”
Bioy says the total cost of a fund is the single most important measure of a tracker, which means weighing up everything from the cost of entry and ongoing charges, to the effects of securities lending and use of futures.
Differing performance can also come from the use of sampling rather than full replication.
Sampling and optimisation are used when the costs of holding all the stocks in the index outweigh the benefits, especially in massive investment universes and for small funds.
Bioy recommends Vanguard’s FTSE All Share Oeic. She notes although investors are hit with a 40bps entry charge, it is an upfront levy to pay for stamp duty.
She says it is fairer to make investors pay the tax upfront as opposed to spreading it among existing investors, and also makes for less tracking difference.
Hargreaves Lansdown passive investment manager Adam Laird says: “When we have found something whose numbers look good, that is when we dig deeper and look for example at how the product replicates, if it lends stock, what the index is, etc.”
Laird recommends the £4.711bn L&G UK Index fund based on these factors, and says it the least likely to run into poor performance in future.
“It is a large fund and has been going for a very long time. It is also very conservatively managed and holds every stock in the index which not all are able to do.”
He does not recommend Fidelity – which offers the cheapest FTSE All Share tracker at 9bps across platforms, because it only partially replicates the index.
Laird adds: “I still prefer the security of knowing it is fully replicated. That way investors are not taking the risk that the performance of the smaller companies makes it deviate.”