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This article has already been emailed to Fools as part of our 'The Good, The Bad and The Ugly' campaign.
Today we're kicking off our 'The Good, The Bad and The Ugly' campaign. Over the next few weeks we'll be looking at a selection of financial products which we rate highly, the 'good' - as well as alerting you to the ones which fall seriously short the 'bad'. We'll also write about some of the scams, rip-offs and scandals that make us angry - 'the ugly.'
But let's start on an upbeat note by looking at one of our favourite 'good' products, the index tracker. An index-tracker fund has a simple investment strategy which is designed to follow or 'track' a particular share index, such as the FTSE 100, with the aim of replicating its performance as closely as possible. So if a particular company accounts for 5% of the value of an index, 5% of the tracker fund should, in theory, be invested in that company.
So why are index trackers Foolish?
Most investment funds are run by professional fund managers who spend their days strategically picking stocks in the hope of yielding a fabulous return for investors like you. Trouble is, you have to pay a price for this expertise and it often doesn't produce sparkling results. In fact, the majority of actively-managed funds produce lower returns than index-tracking funds over the longer-term. What's more, trackers are available at a mere fraction of the cost because you don't have to shell out for a fund manager's salary.
So, in a nutshell that's why we like trackers: better long-term performance at a lower cost.
I think that's a winning formula. My personal choice would be the Legal & General UK Index Trust which is the most popular UK tracker with investors. The fund has net assets of around £4.5 billion which dwarfs all other UK trackers. Although it isn't the only great tracker, here are five reasons why I rate it so highly:
The Total Expense Ratio (TER) Is Low
Or in others words, it's cheap! This L&G tracker has a TER of just 0.53%. The TER covers all the total costs you would have to pay. It's not the lowest cost tracker on the market but I think L&G's fund is very competitive.
The Tracking Error Is Very Low
The tracking error measures how well the fund tracks the index. If a fund is tracking accurately, the error should be low. L&G aims to track the index in a range that is 0.25% above or below the index. Over the last one and three years, the error has actually been 0% which means it's doing a pretty good job to say the least! Most funds don't track the index exactly. L&G tweaks its holdings slightly to get as close to the index as possible after taking account of charges.
The Fund Tracks The FTSE All-Share Index
This index covers around 98% of the UK stock market by combining the FTSE 100, FTSE 250 and FTSE Small Cap Indices into one. In this way it blends large, mid and small cap companies making it more diversified. I prefer All-Share trackers to FTSE 100 trackers which are more concentrated on certain sectors, particularly banking and financial stocks.
The Fund Performs Consistently Well
Don't rely too heavily on past performance as it bears no relation to what might happen in the future. That said, most of us would not be impressed by a fund that always languishes at the bottom of the league tables. Fortunately, L&G's tracker can usually be found closer to the top and it's highly ranked over the last three, five and ten years.
The Fund Is Highly Rated
There are a number of fund ratings agencies who make it their job to tell us which funds are successful in achieving their objectives and which aren't. This tracker has earned a good reputation with some of the most well-known agencies and has been rewarded with high ratings.
You may be wondering why I haven't singled out the cheapest UK tracker - the Fidelity Moneybuilder UK Index - which has a tiny TER of 0.28%. There are two reasons for this. Firstly, the fund holds around 20% of its assets in cash, which has been a long-term investment decision made by the manager. L&G, on other hand, has very little cash and is almost entirely invested in shares which I think is more suitable for a tracker. Secondly, the Fidelity fund has a much high tracking error of 1.89%. That said, the choice is yours! Once you've picked your favourite tracker, don't forget it's often possible to invest in a fund through an ISA, earning you a tax-free return into the bargain.