The passive structure of the funds means they are able to carry lower charges. However, unlike actively managed funds, the vehicles simple track an underlying index and are therefore unable to react to changes in the market.
The constant monitoring of a fund is how active managers justify higher fees – and in many cases this pays off, particularly on the income front.
According to recent FE Trustnet research, FTSE tracker funds by and large trailed their underlying indices when it came to income.
This is especially true in the popular IMA UK Equity Income sector, where funds that track the index are difficult to come by and a number of star managers – including the likes of FE Alpha Managers Neil Woodford, Adrian Frost and Adrian Gosden – dominate the performance tables.
While the strong long-term performance of these industry giants is certainly undisputed, cost-conscious investors can access strong returns with a higher dividend yield through the Vanguard FTSE UK Equity Income Index fund.
Investors can access the five crown-rated tracker via platforms for an ongoing charges figure (OCF) of just 0.25 per cent – significantly lower than the average cost of actively managed funds in the sector, which is 1.66 per cent. This makes it by far the cheapest fund.
While the yield on the tracker fund is middle of the road when compared with the entire IMA UK Equity Income sector, at 3.99 per cent, it is higher than both the FTSE 100 and the FTSE All Share indices. The FTSE 100 is yielding 3.68 per cent while the All Share has a yield of 3.56 per cent, according to The Share Centre.
It is also yielding more than Woodford’s Invesco Perpetual Income and High Income funds, which are paying out 3.29 per cent and 3.21 per cent respectively. The Artemis Income fund, managed by Frost and Gosden, is yielding 3.8 per cent.
While investors would have been better off in an actively managed fund such as Unicorn UK Income, Cazenove UK Equity Income or Royal London UK Equity Income from a total return perspective over the last three years, the Vanguard tracker is still second quartile in the sector, with returns of 54.35 per cent.
The IMA UK Equity Income sector has made 48.45 per cent over the period while the FTSE UK Equity Income index gained 56.01 per cent.
Performance of fund vs sector and index over 3yrs
Source: FE Analytics
The fund has tracked the FTSE UK Equity Income index with an error of 0.33 per cent over a three-year period and is equally as volatile, with an annualised score of 10.7 per cent. The sector has a volatility score of 11.39 per cent.
Unsurprisingly, the fund is comprised of major UK dividend-paying stocks such as GlaxoSmithKline, BP and Vodafone – holdings that all feature in the top-10 of Woodford’s Invesco Perpetual Income and High Income funds, as well as in the Artemis Income portfolio.
While these actively managed funds have held up over the long-term, it may come as a surprise that since launch in June 2009, the Vanguard FTSE UK Equity Income tracker has actually outperformed the Invesco and Artemis portfolios by more than 15 percentage points.
Performance of funds since June 2009
Source: FE Analytics
Standard Life Investments holds the tracker fund in its range of MyFolio funds, as does Architas in its Passive Growth and Passive Reserve vehicles.
Hargreaves Lansdown’s Adam Laird says the fund is one of his favourite products for providing passive exposure to the UK equity income market.
"There’s nothing that really compares in the passive space," he said. "The great thing about this fund is that it is market cap rated, so it is a traditional construction of the index and focused on the largest companies in the UK that have the highest dividend."
"There are several ETFs that do similar things, but they weight stocks by yield so the biggest dividend-paying stocks are the biggest portion of the fund, which builds in risk so that if the price drops, the dividend will drop as well."
"The Vanguard fund is a good option for people who want passive UK equity income exposure."
However, Laird says investors need to keep in mind that passive funds do not have the ability to adjust weightings between sectors as active managers do. He adds that active managers are expected to look for sustainability of income, which means they are likely to deliver strong returns over the long-term.
Charles Stanley Direct’s Rob Morgan agrees that active management has the advantage in this space, but admits for investors concerned with lowering the cost of their overall portfolio, the Vanguard FTSE UK Equity Income Index fund would be a good core holding.
"If you are going to have passive exposure to large cap equity income, this is a reasonable route to go down. You could use it as a core fund and use a satellite approach for small caps," he said.
"However, it’s not my choice. I would use something like Trojan Income or Invesco Perpetual UK Strategic Income and blend with them something more exciting like JO Hambro UK Equity Income."
