Investors should avoid so-called “tracker funds” that attempt to beat their index, or use stock-lending as a means of replicating an index, according to Vanguard’s Nick Blake (pictured).

The head of UK retail says that those who think all trackers are the same are very much mistaken, and should do their research before selecting a product.

“Sometimes you may see managers deliberately trying to outperform the index, because they think they can be clever and make a couple of improvements here or there,” he said. “In my view this is wrong because people haven’t paid to do more than track an index, and that’s what they want.”

Blake warns investors to watch out for this error on the upside as well as the downside. Though outperformance is usually seen as a positive thing, any form of tracking error means the tracker could be susceptible to the sorts of losses sustained by active managers.

He also points to the use of stock lending as something investors need to be careful of.

“There’s nothing wrong with stock lending in itself, but I have heard some managers see it as a good way to off-set their total expense ratio (TER),” he said. “You shouldn’t assume you will make money back from stock-lending, so this is something else investors need to be wary of.”

While Blake doesn’t dismiss emerging market trackers completely, he says investors often buy these products under false impressions.

“Emerging markets are by their nature more volatile – you are taking higher risk investing there rather than in UK equity. Just because you have tracked the index doesn’t mean you are taking a lower risk. You need to decide on your risk appetite first, and then whether you want active or passive as the last question,” he said.

Tracker funds, along with their fellow passive products ETFs, have been growing in popularity, with their low charges seen as a strong selling point.

Ideally the products track an index, aiming at replicating the returns it makes, but managers’ success at this varies.

In March, FE Trustnet produced research comparing the tracking error – the amount by which the fund’s returns differ from the index – of different providers.

Vanguard’s products came out on top on a cost-adjusted metric, while the average annualised error of the major providers varied from 0.79 per cent to 3.67 per cent.

Among the firm’s most popular products is the £416m Vanguard UK Equity Index fund. According to FE data, it’s returned 39.13 per cent over three years – only 0.28 per cent less than the index. Over this period, the product has a tracking error of 1.22 per cent – the third-lowest of the FTSE All Share passive funds in the UK All Companies sector.

Performance of fund and index over 3yrs



Source: FE Analytics

Active managers are often criticised for the lack of transparency surrounding their turnover costs, with some citing their low turnover as an advantage of passive funds. However, Blake thinks this is unfair to active managers.

“There are some people who want to know exactly what your turnover is, but this leads to the idea that a bigger turnover is worse, which is not true.”

“For example, just knowing that the fund has a high turnover doesn’t tell you what the cost of that turnover was if you don’t know the commission costs. On top of that, it obviously misses out the result of those purchases – you don’t know how good the manager’s decisions were.”

Whil Blake is a champion of replicating an index rather than trying to outperform it, he says the nature of some markets means it’s impossible to hold every constituent of the benchmark.

He commented: “We have a global bond fund. In the index it tracks the Barclays Global Aggregate Float Adjusted Bond Index. Rather than buying all the thousands of stocks we have very sophisticated computer programmes that determine how to change the constitution of the fund. It’s not active management, but you do need to work out the parameters of the programme.”

Blake adds that for some indices like the S&P Total Market index – the US equivalent of the FTSE All Share – some of the smaller stocks are so small the costs of buying and selling them individually makes it uneconomic.

Vanguard’s US Equity Index fund tracks the S&P Total Market, tracking 90 per cent of it and using other strategies to replicate the other 10 per cent.

If you can’t afford the minimum investment of £100,000, you’ll need to go through platforms such as Hargreaves Lansdown and Bestinvest to get exposure to Vanguard’s tracker range.