Many investors have shifted their focus from actively beating the stock market to investing in passive or tracker funds. These funds follow a stock market index and provide returns that align with the market average. However, it’s crucial not to be too passive about your passives. If you haven’t reviewed your investments for a while, you may be paying higher fees than necessary. By putting in a little effort, you can improve your performance.
In the UK, tracker funds dominated the retail investment platform during the 2023 Isa season (March and April). AJ Bell’s investors also displayed a preference for passive funds, with nine out of ten most popular funds being passive. This trend indicates a shift towards passive investing, which may extend beyond recent market conditions.
According to the Investment Association (IA), tracker funds in the UK received net retail inflows of £272mn in June 2023, bringing their share of industry funds under management to 21%. This growth aligns with the global trend in passive investing. In 2022, indexed vehicles attracted $747bn in inflows globally, while actively managed funds lost $1.27tn. Passive funds now hold 38% of the global market share, an increase of 2.3% according to Morningstar Direct.
Passive investing offers a convenient approach, favored by long-term “armchair” investors who appreciate the power of compounding. However, for investors nearing retirement with significant assets, risk reduction in their portfolios becomes important. Tracking an index minimizes the risk of portfolio managers making incorrect decisions.
An increasing amount of academic evidence supports the effectiveness of passive investing. Morningstar’s research on US equity market funds revealed that from 2010 to 2020, only 23% of active managers outperformed their passive counterparts. Even if you wish to engage in active management, it’s likely that a portion of your portfolio will be allocated to trackers. Therefore, it’s crucial to optimize their performance.
Start by exploring the expanded range of index funds available. Investigate the popular passive funds on major UK retail investment platforms such as Hargreaves Lansdown, AJ Bell, and Interactive Investor. Hargreaves Lansdown customers are drawn to Legal & General products due to negotiated fee discounts, while Vanguard and iShares products dominate on AJ Bell and Interactive Investor.
Consider incorporating exchange-traded funds (ETFs) into your investment strategy. ETFs, which track indices and often have lower fees than index funds, trade like shares. Oliver Wyman analysis shows that ETFs accounted for 23% of all fund launches in 2022, compared to just 5% in 2016. However, be cautious with thematic ETFs that follow niche sectors, as investors often do not benefit as much as consumers do, leading to an experience similar to active management.
If you invested in a focused passive fund popular a few years ago, such as China or another emerging market, it’s worth reassessing your portfolio’s balance and the wisdom of your previous decision. Explore newer low-cost alternatives to traditional tracker funds. For those interested in global, US, or UK equity indices, there are affordable ETF options available, such as the SSGA SPDR MSCI World UCITS ETF and the Xtrackers S&P 500 UCITS ETF.
Don’t overlook the impact of fees in passive investing. While the passive fund you selected years ago may have seemed like a good value then, it may not hold up today. Some products launched a decade ago may no longer be competitive in terms of pricing, and there are still expensive legacy products in the market.
One example is the L&G Tracker Trust CTF, which launched in 1999 and still charges an eye-watering fee of 1.56% for the £1.3bn invested. As a child trust fund product, this is unfavorable for the children invested in it. While cost isn’t everything, it’s a crucial factor in passive investing.
The Manager versus Machine report by AJ Bell highlights the significant cost differences among UK tracker funds. The most expensive tracker fund is 21 times pricier than its cheapest counterpart. By switching £10,000 from the expensive fund to the cheaper one, assuming a 7% annual growth rate, an investor could be £6,627 better off after 20 years.
For investors with higher stakes, failing to switch to a better-priced product can result in missing out on life-changing amounts of money. Remember that seemingly minimal price differences can accumulate over time, making it crucial to take action now.
Moira O’Neill is a freelance money and investment writer. She holds Vanguard LifeStrategy funds. X: @MoiraONeill, Instagram @MoiraOnMoney, email: moira.o’[email protected]
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