What is a tracker fund?

What you’ll learn:

• What types of investments give you exposure to indices
• How tracker funds work
  
• How to figure out which type of tracker is most suitable for you.

Let’s say you decide to add a tracker fund to your portfolio. You log into your investing account, search for ‘index trackers’ and end up with a long list of potential investments.

It’s important that you choose the right one to suit your needs. But first, you must make sure you understand these types of funds, which are sometimes referred to as ‘passive’ funds.

What is a tracker fund?

These funds are described as ‘passive’ investments as they simply aim to replicate the performance of a benchmark or market index, for example the FTSE 100 in the case of an index tracker.

As they are run using computer algorithms rather than with costly research and managers, these funds are cheaper than the actively managed funds, and offer a cost-effective option to use as a key part of a diversified portfolio. But it’s important to understand that unlike an actively managed fund, a tracker can never outperform the market or index it is linked to – as the name suggests, it will only ever follow it.

Tracker funds can be structured as a unit trust or open-ended investment company (OEIC), or as an Exchange Traded Fund (ETF).

While unit trusts and OEICs are valued and dealt with the manager once a day based on the value of the underlying assets held by the fund – ETFs are bought on the stock exchange at any time throughout the day just like shares.

Besides tracking an index, OEICs and unit trusts can also be made up of portfolios that invest in shares, bonds, property, commodities, or a combination of different asset classes.

Find out more about OEICs and unit trusts

Meanwhile exchange-traded funds (ETFs) track many other areas of investing as well as major markets like the FTSE100 and major US indices. You will find many which track niche industry benchmarks which let you invest in all kinds of specialist areas.

Find out more about ETFs

Which tracker fund is right for you?

You should carefully weigh up the advantages and disadvantages of the different funds before you invest in a tracker. The lower cost of an ETF may appeal, then again, you might be willing to pay more for an OEICs or unit trust if that’s your preference.

Whichever option you choose, your money will be at risk. The value of the underlying investments in any type of index tracker may fall and you could get back less than you invest.

Many tracker funds and ETFs can be held in an Individual Savings Account (ISA), enabling investors to benefit from tax-free income and capital gains. However, remember that tax rules of ISAs can change and that the value of their favourable tax treatment depends on your individual circumstances.