What is an index tracker fund ISA?
Index tracker funds are designed to directly track a stock index in order to replicate its performance.
Index tracker fund managers do not need to outperform a benchmark or make any risk-based investment decisions, so the management fees they charge to their investors are usually a lot lower compared to standard managed funds.
However, while the charges are lower, the investments are not weighted for risk levels or monitored for performance or strategic investment purposes, so they can sometimes be outperformed by managed funds in similar sectors.
How do index tracker funds work?
An index tracker fund aims to replicate the direct performance of a specific stock index, usually by investing proportionately in the underlying shares in that index.
For example, a FTSE 250 index tracker fund will pool its investors’ money together and then spread it across all of the companies listed in the FTSE 250.
It will give each company a weighting based on the market capitalisation of their shares (share price multiplied by the number of shares in issue) so that any movement in each company’s value will correctly affect the overall performance of the FTSE tracker ISA.
What are some examples of indexes that tracker funds invest in?
There are many index tracker funds listed on the London Stock Exchange that track international markets and indexes and you can hold these in a Stocks and Shares ISA account.
This list gives you an idea of why kinds of indexes and sectors you can gain exposure to via an index tracker fund ISA:
- FTSE 100
- FTSE AIM 100
- FTSE techMARK 100
- North American indexes
- Asia Pacific indexes
- Global indexes
- Industry indexes (e.g., technology)
There is a wide range of sectors and indexes available, and some trackers will invest in similar areas so you will need to compare the pros and cons of each to find the best one for you.
What are the benefits of an index tracker fund ISA?
- Invest in an index or sector
Index tracker funds offer a unique ability to invest in a particular index or sector that you think will perform well. Whether it’s technology, the Japanese stock market, or smaller UK companies, you can directly invest in a sector you think will perform well.
- Instantly diversify your portfolio
Instead of picking a handful of companies in a particular index to invest in, you can get exposure to potentially hundreds of companies through one fund.
Not only do you not have to research the individual companies to invest in, but you also benefit from the diversification of your portfolio.
If one company in the index goes bust, the index tracker’s performance will not take as much of a hit as the other 99% of holdings will dilute the effect.
- You will pay lower charges
Perhaps the most attractive factor of index tracker funds is the low management fees.
A managed fund needs to pay professionals to research, monitor and rebalance the fund constantly, which costs a lot of money. This means that they charge their investors more money to cover the costs.
You can find a funds’ charges in the Key Investor Information Documents listed as OCF / TERs.
Typically, an index tracker fund will charge around 0.1%, whereas a managed fund will charge between 0.5% and 1% per annum.
These charges are deducted from within the funds themselves and so are reflected in the overall performance of the funds.
What is the best index tracker fund ISA?
You need to think about two key things when choosing the best index tracker ISA:
- The Stocks and Shares ISA provider you pick
- The actual ISA tracker funds you invest in
Which index tracker fund(s) you invest in depends on your investment strategy and experience, but you should also consider the ongoing charges and whether the specific fund managers have a good reputation.
When comparing index fund ISA providers to choose from, there are some key points to keep in mind:
- Provider Annual Management Charges
- Dealing Fees and other ad hoc charges
- The range of index tracker funds available
- Customer service ratings and reliability
