A study of the nine largest providers of index-tracker funds shows that Vanguard and BlackRock have the lowest average TER, at 0.23 per cent.
With an average TER of 0.3 per cent, HSBC Global Asset Management’s passive funds also fared well in terms of overall cost to the investor. However, the average annualised tracking error on its range is 1.65 per cent, 22 basis points higher than Vanguard’s average. BlackRock’s average annualised tracking error is 2.12 per cent.
Cost and tracking error of passive fund groups
Source: FE Analytics
Insight has the lowest tracking error, with 0.79 per cent; however, the group’s average expense ratio of 0.36 per cent is higher than Vanguard’s, it operates in more obscure markets, and it has fewer funds under management.
Tracking error is a measure of how effectively the instrument has performed in line with the index it is designed to replicate. If the tracking error is high and investors end up performing worse than the index as a result, the advantage of owning a passive fund over an active one is lost.
"Looking at the biggest passive management houses, Vanguard is the one that best combines what an investor is looking for when investing in a passive fund: good replication at a low price," commented Charles Younes, fund analyst at FE.
By far the most expensive provider in the UK tracker market is Standard Life Investments. With an average TER of 1.62 per cent, the cost of investing in a Standard Life tracker is closer to that of actively managed products.
At 3.67 per cent, the group’s average annualised tracking error was also the highest of the houses featured in the study.
Tracker funds are designed to automatically replicate a broad market index to give investors direct access to a particular market. The main advantage of this type of investment is that it does not require the full-time attention of a professional fund manager and therefore the cost of accessing the fund is much lower than actively managed alternatives.
Proponents of trackers say many actively managed funds often fail to beat the index, therefore owning trackers guarantees the investor receives at least the market average at a lower cost. However, investing in this way also eliminates the chance of outperforming the market. The very best fund managers have proven their ability to do this time and time again.
Adrian Lowcock, senior investment adviser at Bestinvest, says that passive instruments are better suited to some markets than others.
"On the whole we prefer active managers, but if there are certain markets where it is inherently difficult to add value, we tend to go for a tracker," he said. "The best example of this is the US market where, ironically, it has become extremely difficult to add Alpha because trackers are so dominant."
The study also indicates that the majority of investors want a product that can replicate the index with which they are most familiar.
Younes commented: "The most replicated index is the FTSE All Share, with 22 passive funds. The Vanguard FTSE UK Equity Index is the fund that succeeded the most in replicating the index, with an annualised tracking error of 0.03 per cent."