#index tracking

[oneminutemoneymagazine]

Index Tracking or Passive Funds

As the name implies, these funds are designed to track the performance of a stock market index, the most commonly used in the UK being the FTSE All-Share Index.  Their success is measured not by whether they outperform their index, but by how closely they track it.

The natural approach is to hold shares in every company in the index, which is known as full replication.  In order to reduce running costs, funds can hold shares in a smaller number of companies, but need to be careful that this does not affect the accuracy of their tracking too much.  Some funds also use financial instruments.  Passive funds do not need to employ expert decision makers (as more conventional actively managed funds do) and therefore their annual management charges should be lower.

So which is better: active or passive management?  By definition, a passive fund will produce an average performance plus any gain from a lower management charge.  I tend to use the slightly lower risk passive approach.  However, if you feel that you can select a good active manager, please go ahead and back your judgement.

Certainly passive funds have been steadily increasing in popularity since American bank Wells Fargo introduced them to the UK in the 1970s.  [Older readers may remember Dale Robertson in the 1950s/60s TV series Tales of Wells Fargo which featured adventures in the early days of that bank.]

Finally here’s a philosophical thought.  If all investment were to be passive, there would be no one to influence share buying in any particular direction and little would change.  Stock markets will always need at least some active investors.

(13/02/2021)

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ETF Funds: A Simple, Transparent Way to Grow Your Wealth

In the world of modern investing, ETF funds—Exchange Traded Funds—have quickly gained popularity for their simplicity, flexibility, and low cost. For beginners and seasoned investors alike, ETFs offer a smart way to build a diversified portfolio without the complexity of actively picking individual stocks.

ETF funds are essentially baskets of securities—like stocks, bonds, or commodities—that track a specific index. Since they replicate an index rather than trying to outperform it, ETFs come with lower expense ratios compared to actively managed funds. This cost efficiency makes them especially attractive for long-term investors looking to maximize returns.

One of the biggest advantages of ETFs is their transparency. Investors can clearly see the index and the exact securities the fund holds. And because ETFs trade on the stock exchange just like shares, buying and selling them is incredibly convenient. This liquidity makes ETFs versatile for both long-term investing and short-term strategies.

Interestingly, while ETFs are not traditionally associated with systematic investing, many investors now combine them with a disciplined SIP approach. By investing a fixed amount regularly—say monthly—you can average out purchase costs over time and reduce the impact of market volatility. SIP into ETFs is gaining traction as more investors seek a low-cost, passive way to grow wealth steadily.

ETF funds also allow you to diversify across various themes—large-cap indices, international markets, gold, debt, and even sector-specific indices. This makes it easier to create a balanced and personalised investment strategy.

However, like any market-linked product, ETFs come with risks. Prices fluctuate with the index they track, and returns are not guaranteed. But for investors who prefer transparency, flexibility, and long-term consistency, ETFs are an incredible building block.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

[oneminutemoneymagazine]

Index Tracking Funds versus Actively Managed Funds (Part 2)

Suppose you have decided that you wish to invest in a fund which will produce a return broadly in line with the FTSE 100 Index.  You now need to select an investment manager who may offer an index tracking fund (aka as passive management), an actively managed fund or both.  How do you go about choosing?

Firstly you will not wish to increase your record keeping by investing with too many different fund managers.  In fact, in the case of stocks and shares ISAs, you are only allowed to use one provider in the current tax year.  Let us suppose that a manager you tend to favour has an annual management charge of 0.75% for their index tracking fund and 1.25% for their actively managed fund.  The question becomes whether their active management skills can over a period of time enhance their performance by more than 0.5% per annum (the difference between 0.75% and 1.25% per annum).

Now is the time to read the investment manager’s literature.  Under “Investment Objective” or something similar, you may read “The objective of this trust is to track the performance of the UK equity market as represented by the FTSE Index”.  The word “track” indicates that the fund is index tracking and hence not managed actively.  You will also need to know the annual management charge.

For an actively managed fund, you should see how their investment performance compares to the index (allowing for the adjustments for reinvested income and annual management charge) over each of the last (say) five years.  If you can’t find it easily in the literature, write and ask for it.  If you get an evasive answer, you know that they have underperformed!

If, however, their actively managed fund has performed well over the last five years as a whole, then it is probably a good idea to invest some or all of your money there.  Do keep investment performance under review in the future.

(31/12/2015)

[oneminutemoneymagazine]

Index Tracking Funds versus Actively Managed Funds (Part 1)

There are many stock market indices, but the best known in the UK is the FTSE 100.  This looks at share price movements for the 100 largest (by stock market capitalisation) UK companies .  Suppose that, on average, these share prices move up overall by 1% over the course of a day.  In that case, the FTSE 100 Index would also rise by 1%, e.g. if it were 6500 yesterday, it would rise to 6565.

Each of the 100 companies should also pay a dividend to shareholders, hence the pure index performance as above would be increased to allow for this.  If an investment fund were to buy and sell stocks with the sole objective of matching the index (or average holding), it would achieve a performance equal to the index increased to allow for reinvested income.

There is also an annual management charge typically in the range of (say) 0.5% per annum to 1% per annum.  An index tracking fund has no ambition to beat the index.  It should simply produce a rate of return equal to the index performance plus an allowance for reinvested income minus an allowance for the annual management charge.  Any deviation whether positive or negative is known as a tracking error.

The alternative and traditional investment approach is known as active management.  An active investment manager takes a view as to which shares to buy, hold and sell and hence achieves a performance which is hopefully better than the index or average return.  However, an active manager’s expenses will be higher and this is often reflected by a higher annual management charge.

Part 2 of this short series will explain how to choose between index tracking and actively managed funds.

(30/12/2015)