What are Index Tracker Funds and how they work | The Share Centre

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What is a tracker fund?

Tracker funds definition

Index tracker funds aim to closely track the performance of an index (such as a FTSE 100 tracker fund) by investing in companies within the index they track. Since they are passively managed, they are often more cost-effective than funds which are actively managed by fund managers. 

The benefits of index tracker funds

Cost-effective
The Annual Management Charge (AMC) for index tracker funds is comparatively lower than for actively managed funds and there is no Stamp Duty to pay. There may be entry charges, so you will need to check a fund's Key Investor Information Document (KIID) for more information on individual charges.

Convenient
Index tracker funds can give you exposure to entire markets without having to spend time and money buying individual investments; and there's a vast selection of funds to choose from, covering different indices, geographical regions and market sectors. 
They can be held in Share Accounts, ISAs, Junior ISAs, Child Trust funds and Self-invested Personal Pensions. Performance is easy to monitor and they can be bought and sold each working day at the next available Valuation Point.

Diversification
In addition to the benefits of exposure to entire markets, diversity of sectors within an index can be broad; so poor performance in one sector can be outweighed by positive performance in another. Also, with a passively managed index tracker fund, you don't have to rely on a fund manager’s stock picking ability!

Lower, medium, or higher risk index tracker funds?

For your convenience, we give all our preferred index tracker funds a risk rating to help you choose according to your own personal attitude to risk. For more information on how we define lower, medium and higher risk invetments, please refer to our investment research policy.   

What's an index?

Indexes represent the performance of stock markets. For example, the FTSE 100 represents the performance of the 100 largest companies listed on the London Stock Exchange (LSE).

Due to corporate actions and companies moving in/out of indexes, their constituents are rebalanced at various times throughout the year. When this happens, fund managers buy and sell investments to reflect the changes.

  • Annual Management Charge (AMC)

    Annual management charge levied by the fund manager to pay for their services in managing the funds, reflected in the price of units on a daily basis.

  • Currency Risk

    The risk of incurring losses in the value of overseas investments as a result of movements in international exchange rates. Can also refer to the additional volatility caused by exposure to assets in foreign currencies.

  • Derivative

    A financial contract whose value is derived from a stock, commodity, interest rate, currency or market index. A stock option, for example, is a derivative security whose value depends on the price of the underlying stock. Derivatives can be used by investors as a speculative tool, or to protect assets against changes in value. See also forward contract, futures contract, call option, put option and swap.

  • Index

    An index is essentially an imaginary portfolio of securities representing a particular market or a portion of it. Each index has its own calculation methodology and is usually expressed in terms of a change from a base value.

  • Ongoing Charge (funds)

    The ongoing charges figure reflects the overall cost of managing and operating a fund. It includes the annual management charge and additional expenses such as trading fees, legal fees, auditor fees and other operational expenses. It is quoted on a fund's Key Investor Information document (KIID).

How do index tracker funds work?

There are various methods used to replicate the performance of an index, either by full replication or partial replication:

Full replication
The fund manager mirrors the investments within an index using a very similar weighting. For example, a FTSE 100 tracker fund using this method would invest in all 100 companies, using their weighting within the FTSE 100 to determine representation.

Partial replication
The fund manager does not hold all of the investments within an index, as it may be costly to invest in the smaller constituents. Instead, they choose investments to represent industry sectors. For example, if the financial sector represents 25.9% of the FTSE All-Share index, approximately 25.9% of the fund would be invested into a selection of financial companies which the fund manager believes will best replicate the sector's performance. Other factors included in this method are currency, country, company size, price-to-earnings ratio, yield, debt-to-assets ratio and beta.

Things to bear in mind

Before investing in index tracker funds, please consider the following:

  • A fund tracking the index aims to match the performance whether it is going up or down. Therefore in a declining market, the fund will follow the index down.
  • If an index is heavily weighted to a particular sector or region which performs badly, it will have a greater impact on the fund and vice versa.
  • The tracking error can be distorted due to the difference in the valuation point of the fund and the valuation point of the index it tracks.
  • Some fund managers engage in stock lending, opening up the fund to higher levels of counterparty risk from defaults on the loan contract. 

preferred index tracker funds

preferred index tracker funds

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