Besides being cheaper than active portfolios, index tracking funds or exchange traded funds (ETFs) can offer investors a cheap and effective method of taking advantage of rising markets, though they should be aware that passive investments will also fall in line with their relative index.Hughes, fund manager at Apollo, says the team uses passive funds to gain beta, or correlated risk to a relative benchmark.
Whitechurch runs passive-only portfolios for clients wishing to reduce the cost of their investment. It also uses passive funds for core equity exposure and picks up actively managed funds to dampen risk or pick up further upside.
Here are five cheap passive investments the two firms are recommending for the 2014 ISA season.
L&G US Index
One region where Whitechurch prefers to use passive funds over actively managed ones is the US, where Haynes says fund managers struggle to outperform the market.
He likes the L&G US Index tracker, which has ongoing charges of just 0.82 per cent.
“We’re impressed with the tracking qualities and charging structure [of the fund],” he said.
While the tracker has consistently outperformed the IMA North America sector in all but the last 12 months, it has tended to lag behind its benchmark, the FTSE USA Index, highlighting just how difficult it can be to beat this market.
The fund has made 117.99 per cent over the past five years while the benchmark has gained 130.48 per cent, according to FE Analytics. The sector gained 113.97 per cent over the period.
Performance of fund vs sector and index over 5yrs
Source: FE Analytics
The fund has a tracking error of 5.7 per cent over the last five years.
It invests in some of the largest companies on the US market, by virtue of its passive nature. Major US corporations Apple, Google and Microsoft are among the top-10 holdings.
The fund requires a minimum investment of £500.
Vanguard FTSE UK Equity Income Index
For investors who are looking for a cheap way to boost their income, Haynes likes Vanguard FTSE UK Equity Income Index, which tracks the FTSE UK Equity Income index.
The fund has closely hugged the benchmark since launch in June 2009 and has ongoing charges of just 0.25 per cent, far lower than the average actively managed income fund.
The fund has beaten the sector average over the last three years, and has performed in line with the index, returning 44.45 per cent.
Performance of fund vs sector and index over 3yrs
Source: FE Analytics
It is also yielding 4.03 per cent, slightly higher than the average yield of the IMA UK Equity Income sector at 3.8 per cent.
It holds many of the UK’s top income paying stocks, such as BP, Vodafone and GlaxoSmithKline.
The Vanguard tracker is available via certain platforms.
HSBC European Index
Europe is an area Haynes is feeling more and more positive about as valuations continue to diverge between US and European stocks.
“The macroeconomic risks continue to bubble under, but the gap between US and European stocks justifies the added macro risk at the moment,” he said.
The HSBC index tracker offers a cheap way to access the European rally, with ongoing charges of just 0.28 per cent.
The fund also has a yield of 2.58 per cent.
The tracker has largely fallen in line with its benchmark, the FTSE Developed European ex UK index over the last one, three, five and 10 years, although it has tended to lag behind the IMA Europe ex UK sector.
The fund has made 102.34 per cent over the last five years, compared with 107.78 per cent and 113.20 per cent from the sector and index, respectively.
Performance of fund vs sector and index over 5yrs
Source: FE Analytics
The top holdings in the tracker include Swiss food producer Nestle and Swiss pharmaceutical giants Roche and Novartis.
French pharma company Sanofi and German pharma behemoth Bayer are also in the top-10.
HSBC European Index is available via platforms.
BlackRock CIF Emerging Markets Equity Tracker
Emerging markets have been down and out for some time, particularly since the market correction in the middle of last summer.
However, valuations are getting so low and the sector is so under-owned that it is starting to look interesting, according to Hughes.
While he says he would prefer to go back into emerging markets through an actively managed fund in order to mitigate some of the risks, BlackRock CIF Emerging Markets Equity Tracker represents cost-conscious investors' best bet.
The fund has ongoing charges of 0.27 per cent and a yield of 2.71 per cent.
The fund has had a tough time over the last several years, shedding money along with the FTSE All Emerging Index and IMA Global Emerging Markets sector.
The fund is down 11.92 per cent over the last three years, less than the 19.17 per cent fall from the index, but more than the 8.57 per cent drop from the sector.
Performance of fund vs sector and index over 3yrs
Source: FE Analytics
Investors will need to take a long-term view and be braced for volatility and potential further declines in emerging markets, but Hughes says the fact that the sector is now more under-owned than at any point in its history is a good indicator for contrarian investors to think about getting back in.
It is available via platforms.
iShares MSCI Japan GBP Hedged
The one passive Apollo currently owns, according to Hughes, is the iShares MSCI Japan GBP Hedged fund.
The team likes the exchange traded fund (ETF) because it is a play on the weakening Japanese yen. Hughes adds that actively managed funds that hedge their currency exposure are hard to come by.
The team also likes the fact that ETFs tend to be cheaper than even passive funds.
He points out that the iShares ETF has ongoing charges of 0.5 per cent while the BlackRock Japan tracker fund charges 0.52 per cent.
“We can shave off a couple of basis points, which is meaningful,” he said.
The iShares ETF is benchmarked against the MSCI Japan index, which it has strongly outperformed over the last 12 months, largely due to the decreased currency risk.
It made 23.81 per cent over the last year while the index gained 6.21 per cent.
Performance of fund vs index over 1yr
Source: FE Analytics
It is available via select platforms.
