Vanguard, iShares and Lyxor are the fund groups that have the most top-rated products under the new FE Passive Fund Ratings, which FE has built to give investors a better idea of the quality of funds in the index-tracking market.
The FE Passive Fund Rating is the most extensive rating system of index trackers funds in the retail industry, allowing investors to objectively compare conventional trackers and exchange traded funds (ETFs) with each other for the first time. We have launched a dedicated Passives Funds section on the site that allows advisers and investors to filter out passive funds in a number of different ways, including by FE rating. 
The ratings system, which judges passives principally on tracking difference and tracking error, reviews more than 250 ETFs and passive funds to offer greater insight into the passive funds industry. FE’s guide to investing in passive funds can be found here, while the full methodology used to calculate the FE Passive Fund Rating is here.
Michael Holland, managing director at FE, said: “What these ratings show is that past tracking ability of a passive fund can be used as a guide to how well that group will track an index in the future. The difference between the best and worst trackers/ETFs is large and makes a significant impact on the value of your investment.”
Looking at how many groups have the most funds with a FE Passive Fund Rating of five, which is the highest score, iShares leads with a total of 13, out of 31 funds with a long enough track record to be rated. The BlackRock-owned firm also has 11 with an FE Passive Fund Rating of three, one with two Crowns and six with one.
The group is the largest ETF provider in the world, with more than 700 products listed globally. Some 37.8 per cent of total ETF assets under management worldwide are invested in iShares funds, according to the firm.
Vanguard follows with seven funds out of 12 winning the top score. It has one fund in each of the four and three ratings bracket, while two have two Crowns. Lyxor Asset Management is next with six top-rated passives, followed by UBS with five.
Meanwhile, HSBC, Deutsche Asset & Wealth Management (DB) and Amundi have four top-rated vehicles; Source has three; BlackRock has two; and CAF, F&C, Fidelity, Santander, Pictet Funds (Europe), State Street Global Advisors (SSgA) and Scottish Mutual have one each.
Source: FE
UK passives
Our ratings system shows that investors seeking passive exposure to the UK have the choice of quite a number of funds that have won the top FE Passive Fund Rating.
Products with the top score and tracking the FTSE All Share include BlackRock UK Equity Tracker, CAF UK Equitrack, DB X-Trackers FTSE All Share UCITS ETF, F&C FTSE All Share Tracker, Fidelity Index UK, Scottish Mutual UK All Share Index, SSgA UK Equity Tracker and Vanguard FTSE U.K. All Share Index.
Vanguard FTSE U.K. All Share Index has a tracking difference of just 0.28 percentage points over a three year period and a tracking error of just 0.04 per cent. The £3.78bn fund is also extremely liquid. A full breakdown of how the rating is calculated is found here.
Performance of fund and index over 3yrs
Source: FE Analytics
Those seeking large-cap exposure will find that DB X-Trackers FTSE 100 UCITS ETF Income, HSBC FTSE 100, iShares Core FTSE 100 UCITS ETF, Lyxor UCITS ETF FTSE 100, Santander Stockmarket 100 Tracker Growth and Source FTSE 100 are highly rated.
Amundi ETF MSCI UK and iShares MSCI UK UCITS ETF are also top rated and give exposure to large-caps, this time through the MSCI United Kingdom index.
Only one fund tracking the FTSE 250 has achieved five Crowns – HSBC FTSE 250 Index. There are only six other passive vehicles offering exposure to this part of the market.
US passives
The US is a common market for investors to take a passive approach. Because the US market is so closely covered by analysts, information is quickly priced in and it is difficult for active managers to outperform.
The S&P 500, which is mostly a large-cap index, is what most people think of when they refer to the US stock market. It covers about 75 per cent of the total US market by market cap and is made up of the 500 companies in leading industries of the US economy.
Eight products have won the top rating from FE’s analysts: the ETFs offered by Amundi, HSBC, iShares (which has two making the cut), Lxyor, Source and UBS all have S&P 500 in their name, while Vanguard US 500 Stock Index is the only traditional tracker to hold the top rating.
Alternatively, investors can track the MSCI USA index. This covers more companies than the S&P 500 – 628 – and claims to represent 85 per cent of the free float-adjusted market capitalisation in the US. Amundi, DB, HSBC, iShares, Source and UBS have MSCI USA funds with a FE Passive Fund Rating of five.
In total, 15 US-focused trackers and ETFs have been awarded the full rating.
Those wanting to look outside of the S&P 500 and MSCI USA, such as to the small cap Russell 2000 index, do not have any top-rated options. However, DB X-Trackers Russell 2000 UCITS ETF, ETFS Russell 2000 US Small Cap GO UCTS ETF, and Source Russell 2000 do hold a score of four.
Europe passives
Europe is the closest market to the UK, so is a natural first stop for investors looking to diversify away from their core UK holdings. Despite continued doubts over the eurozone’s future and economic setbacks, many of the region’s businesses are strong names with international markets and relatively attractive valuations.
Two funds tracking the region’s lap-cap index – the Euro STOXX 50 – have the top rating: iShares Core EURO STOXX 50 UCITS ETF and Lyxor Index Euro Stoxx 50. Another 10 funds track this index and none have a score lower than three.
The iShares MSCI Europe ex-UK UCITS ETF also has a score of five. This product aims to mirror the performance of 332 large and mid-cap in the 14 main developed European countries.
The ETF has a tracking error of 0.85 per cent versus its MSCI Europe ex UK benchmark over a three year period, and has a tracking difference of 2.34 percentage points. It's actually beaten the index by this figure over the period, but the FE Passive Fund Rating does not distinguish between outperformance and underperformance.
Performance of fund and index over 3yrs
Source: FE Analytics
Investors interested just in the eurozone have more five-score options to choose from, with five products holding the top rating and tracking the MSCI EMU index. These include offerings from Amundi, Lyxor, UBS and Vanguard.
The MSCI EMU index tracks 240 companies based in Austria, Belgium, Finland, France, Germany, Ireland, Italy, the Netherlands, Portugal and Spain. It covers around 85 per cent of the European Economic and Monetary Union’s market cap.
There are also a number of sub-indices offering more specialised exposure to eurozone equities. Top-rated products tracking these include Lyxor UCITS ETF MSCI EMU Value and Lyxor UCTIS ETF MSCI EMU Small Cap.
Japan
In addition to Europe, Japan is seen as one of the main areas of value left in developed markets. The country had been relatively ignored by investors thanks to a two-decade deflationary spiral but the bold economic reforms announced by prime minister Shinzo Abe sparked renewed interest and prompted a market rally. As I write, the Nikkei 225 has just broken the 20,000 barrier for the first time in 15 years.
Those seeking a passive option for the country, however, have a relatively limited choice when it comes to funds rated highly by FE. Only the Vanguard Japan Stock Index, which tracks the MSCI Japan index and its 314 constituents, holds the top score.
Another 14 passive funds offer exposure to Japanese equities, including four tracking the more familiar Nikkei 225 and Topix indices, but none have scored more than three under the ratings system.
Emerging market passives
Global emerging markets offer investors the potential for high growth, as the underlying economies are still in a long-term expansionary trend and have favourable demographics. Although they have lagged the developed world over recent years, many investors want long-term exposure to this asset class.
Given the broad spread of countries and the need to take a selective approach when picking stocks, owing to general lower standards of corporate governance, an active approach is the most common way of investing in emerging markets.
Nevertheless, a number of FE Trustnet articles have shown that active managers in the IA Global Emerging Markets sector have failed to consistently add value relative to their benchmarks.
Therefore, those looking for passive exposure have a top-rated fund to consider: Vanguard Emerging Markets Stock Index.
This fund tracks the MSCI Emerging Markets index and therefore has 23.11 per cent in China, 14.99 per cent in South Korea, 12.83 per cent in Taiwan, 7.95 per cent in South Africa and 7.47 per cent in India.
Two other passive vehicles have won a score of four in the ratings: HSBC MSCI Emerging Markets and UBS MSCI Emerging Markets UCITS ETF.
Bond passives
Bonds are another asset class that are often deemed unsuitable for passive investing. This is because indices are weighted by the largest debt issuers, meaning a passive fund will by default have more exposure to businesses with higher debt burdens.
But for those that do want passive exposure to bonds, there are several top-rated indexed funds targeting different parts of the market.
Exposure to conventional gilts can be taken through products such as Vanguard UK Government Bond Index, iShares Core UK Gilts UCITS ETF and iShares UK Gilts 0-5yr UCITS ETF.
Meanwhile, iShares £ Index-Linked Gilts UCITS ETF tracks index-linked gilts and offers investors a degree of protection against inflation.
Those willing to take on more risk can also invest passively in corporate bonds. The passives in this area with FE’s top rating are Vanguard UK Investment Grade Bond Index, iShares £ Corporate Bond 1-5yr UCITS ETF, iShares £ Corporate Bond ex-Financials UCITS ETF and Blackrock UK Credit Bond Index.
Given FE’s new rating system, the FE Trustnet team will be paying more attention to passive funds through a series of articles focusing on this part of the market and greater attention to index-tracking options when highlighting highly regarded funds.