Your Money: The right track

The perfect 'no-brain' investment may save on expensive fund managers, but keep an eye on the charges. Andrew Verity investigates the tracker

Investors who are used to hearing the message that the more an investment grows, the better, may have been surprised by the latest spate of deals offered by some major financial services companies.

In this case, the companies insist, you may have picked the wrong company if you invest in a fund that grows too much. NatWest, Legal & General, Virgin, Marks & Spencer and Gartmore - all have funds which must not do too well.

The reason for this surprising logic is that the funds in question are "trackers" - funds which aim to mirror the performance of a financial index such as the FT-SE 100 or the American S&P 500. If the index goes down but the fund does not, then the fund manager is failing to do the job.

Tracker funds, most commonly available in PEPs, are known to financial services professionals as a "no-brainer". There is very little need for financial advice.

There is no need to worry about whether your investment manager is picking the right stocks. Theoretically, the investment manager cannot make mistakes as it is a computerised system.

The fund will invest proportionately to reflect fluctuations in, say, the shares of the top 100 companies in the FT-SE index. As the FT-SE 100 rises and falls, so in theory will the fund's performance. The GA Blue Chip Tracking Trust, launched last month by General Accident, one of the UK's top life companies, is among those tracking the FT-SE 100.

But won't you miss your fund manager? After all, the best managers must be paid up to pounds 1m a year for something - presumably the ability to get better returns than average. Some large investment houses such as M&G insist that they consistently out-perform indices over the long-term. Active fund managers, they say, are necessary - especially in a climate where the stock market is widely predicted to be set for a fall.

Those selling tracker funds have an iconoclastic retort. They cite statistics showing that up to 75 per cent of all actively managed funds perform worse - not better - than the FT-SE over five years. Despite predicted falls in the market, there has not been a five-year period when the FT-SE has fallen overall in the last 30 years.

Gartmore, BZW and Legal & General are by far the largest managers of tracker funds, managing more than pounds 40bn. They point out that while astute trustees of pension schemes have long invested up to a fifth of their money in trackers, individual investors have not followed their example. Index-linked funds hold just pounds 3bn out of pounds 120bn in unit trusts.

Meanwhile, returns so far have not been disappointing. On the back of a good year for the stock market in 1996, Virgin's fund (managed by Pearl Assurance) returned 17.9 per cent. Legal & General's earned 18.5 per cent.

It's a simple, no-brain investment. Or is it? While the principle of tracking an index is easy to understand, it cannot all be done by computer. Gartmore's index-linked funds expert, Rick Lacaille, says: "You can't just turn a computer on and walk off. Experience counts in tracking the index."

If a takeover removes a company from the FT-SE 100 index, the money invested in those shares must be redistributed throughout the rest of the FT-SE 100 companies in proportion to their size. This can require human input to decide how to redistribute.

Humans must also decide whether to track every company in the index, which can mean paying stockbrokers a mint in dealing fees - or simply try to mimic the performance of each sector in the index.

Lacaille points to evidence that some tracker funds may be underperforming the index to a surprising extent, sometimes falling short of the FT-SE by up to 5 per cent. For example, while HSBC's Footsie Fund returned 16.81 per cent in the year to January 31, Midland's FT-SE 100 Index Account returned 12.07 per cent.

Part of this is due to charges. Most fund managers levy a management charge of 0.5 to 1 per cent. But some companies ask for an initial charge of up to 5 per cent and their returns drop dramatically. While the HSBC fund has charges of just 0.5 per cent per year, the Midland fund has a bid/offer spread of 4.5 per cent. Govett's fund, based on the FT-SE mid- 250, returned just 6.75 per cent, largely because of a 6.5 per cent charge.

The GA PEP, by contrast, levies no initial or exit charges, ensuring that, in common with other funds levying similarly low fees, its performance should mirror the market more closely.

If the FT-SE 100 suffers a long-expected correction this year, trackers should follow it down. Over more than five years, it is likely to return to growth. But if investors watch charges and invest for at least five years, few may miss their expensive active fund manager.

'The Independent' has published a free 32-page guide to PEPs, sponsored by General Accident Life. The guide explains the difference between tracker funds and actively managed PEPs. For your copy, call 0500 125888 or fill in the coupon on this page.