Follow that bear: tracker funds claim supremacy as the stock market slides

But as Virgin finds fault with the stock pickers, Melanie Bien reports that investors would be better off finding a good active manager

Investors in tracker funds are having their loyalty tested by the poor performance of the stock market. Attracted to these funds in the first place by their low charges, investors are finding that as they track an index, there is little chance of positive returns when shares are doing so badly.

Investors in tracker funds are having their loyalty tested by the poor performance of the stock market. Attracted to these funds in the first place by their low charges, investors are finding that as they track an index, there is little chance of positive returns when shares are doing so badly.

Even so, a new report from Virgin Money, which offers a tracker fund, reveals that 60 per cent of active fund managers in the UK performed worse than the stock market last year. The research suggests that while tracker or passive funds aren't doing brilliantly, active ones are doing even worse. And investors in these are paying more for the privilege.

"The myth has persisted that a fund manager will give you better returns in a bear market," says Gordon Maw, a director at Virgin Money. "We now know that tracker funds beat the majority of managers whichever direction the market is heading in."

However, while 40 per cent of active managers outperformed the stock market, no tracker funds can say they did the same. "Trackers always underperform the market once you allow for charges," says Donna Bradshaw, director at independent financial adviser Fiona Price & Partners. "After all, they have running costs which their index doesn't."

Fans of active management naturally disagree with Virgin's claim that come bull or bear market you'd be better off with a tracker. Rob Page, marketing director at New Star Asset Management, which runs a number of active funds, says: "The findings are rubbish because if you look retrospectively at the active fund universe, a number are closet trackers anyway. If you strip out the 75 per cent of funds which claim to be actively managed but aren't, you are left with active pickers such as us, Fidelity and Artemis. And decently managed active funds will outperform in a bull market, annihilating the performance of a tracker."

He believes this is even more the case in times like these. "In a bear market, a tracker is the worst place to be," he says. "If you are tracking an index, you will track it going nowhere quickly. You are much better off with a good fund manager with a long active track record."

The tracker versus actively managed debate has been raging for several years. Tracker funds are famed for having no initial set-up fee – which can be as high as 5 per cent on an active fund – and low annual fees because they aren't run by a manager. Instead, a computer program follows an index or basket of shares. Many investors favour trackers because they are not subject to the whims of an active manager.

However, active managers argue that while investors may be paying more, they are actually getting better value for money. Annual management fees may be 1.5 per cent or so, compared to 1 per cent or under for a tracker, but the active fund manager picks stocks which he or she believes are going to do well. A tracker has stocks in its fund simply because they are listed on a certain index, irrespective of whether it's a good time to invest in those companies.

Trackers might also invest in quite a limited range of stocks, so increasing the risk. For example, the 12 largest shares in the FTSE All-Share account for over 50 per cent of the entire index – a very small fund universe. And while a tracker will have to hold these stocks simply to follow the market, an active manager will try to outstrip it.

Even Virgin agrees. "Every fund manager worth his salt has a brief to beat the market," says Mr Maw. "Ours is to track it as closely as possible."

There is the potential for big returns if you pick the right active manager. If you don't, of course, you could lose money. However, trackers lose money as well – as we are seeing now.

Even though they are not low risk, as your investment can be wiped out if the market takes a dive, trackers remain popular investments. They might be useful for first-time investors in the stock market, although a better alternative would be a broad UK equity fund with a good track record.

"If you do go for a tracker, go for a cheaper one than the Virgin product," warns Ms Bradshaw at Fiona Price & Partners.

Many people are attracted to trackers by their low charges, so make sure you don't pay more than you need to. Investors often don't realise there is a difference in fees, with Virgin charging 1 per cent per annum compared with M&G's 0.3 per cent. Given that trackers do nothing but follow an index, there is little reason to pay over the odds.

However, Mr Maw defends Virgin's charges. "We offer a range of services to our customers, such as the ability to contact us at weekends if they need to, and we put a lot of effort into our product literature," he says. "And everything we sell is 1 per cent, so people know where they stand. Our customers are comfortable with what we charge."