A Beginner’s Guide to Tracker Funds

  • Ashesh Anand
  • Nov 12, 2021
  • Financial Analytics
A Beginner’s Guide to Tracker Funds title banner

What is a Tracker Fund?

 

A tracker fund is an index fund that follows the performance of a broad market index or a subset of it. Tracker funds, often known as index funds, are meant to provide investors with low-cost exposure to an entire index. To accomplish the fund's tracking objective, these funds attempt to duplicate the holdings and performance of a defined index using ETFs or alternative investments.

 

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How does the Tracker Fund Work?

 

The tracking function that underpins index fund management gave rise to the phrase "tracker fund." The goal of tracker funds is to mimic the performance of market indexes. The number of tracker funds accessible in the market has increased dramatically as a result of industry innovation.

 

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Investing in an index fund is a passive investment strategy. Index funds were first established to provide investors with a low-cost investment vehicle that allowed them to have exposure to a market index's various securities. The lower expenditure ratio on an index fund is the key benefit of such a scheme.

 

The majority of tracker funds are either profit or accumulation units. In the first case, income is distributed to fund investors in the form of cash. The money is saved in the latter situation for reinvestment within the fund.

 

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How do trackers keep track of their targets?

 

Passive investment funds imitate the performance of an index in one of two ways.

 

  • Full Replication

 

This is the process of purchasing all of an index's components. An FTSE 100 tracker fund, for example, will purchase shares in each of the index's 100 businesses in proportion to their size. This means that funds can try to match the index's performance as closely as possible.

 

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  • Partial Replication

 

When purchasing all of the shares in an index is impossible, some passive funds invest in a sample of the index that is reflective of the entire index.

 

The MSCI World index is a good example of this. More than 1,700 enterprises from 23 countries are represented. The time and money required to hold all of the companies in the index for full replication could be detrimental to the portfolio's performance.

 

Instead, partially replicated passive funds will buy a sample of the most representative companies inside the index.

 

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Pros of Tracker funds

 

Here are some of the advantages of tracker funds and how they can assist you in meeting your investment objectives:

 

  • Tracker funds are 'passive investments,' which means you simply have to buy the fund's shares. You won't have to worry about deciding which assets to include in the fund, and you won't require a lot of financial knowledge because the fund provider will handle everything for you.

 

  • Because their value is defined by the share prices of a collection of different firms, tracker funds provide you with diversified exposure to the financial markets. 

 

As a result, if the stock of one of these companies declines in value, it is unlikely to have a significant impact on the fund's overall performance. Keep in mind that certain tracker funds are more varied than others; an all-world tracker, for example, is more diversified than a technology tracker.

 

  • Tracker funds typically provide broad financial market exposure at a cheaper initial cost than buying each asset separately.

 

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Cons of Tracker Funds

 

Before you invest in a tracker fund, you should be aware of the following disadvantages:

 

  • You will not have direct ownership of any shares or other assets if you invest in tracker funds.

 

  • Tracker funds contain underlying costs that you'll have to evaluate fund by fund.

 

  • You can't customize your investments since tracker funds don't let you control what goes into them. 

 

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Special Points to Consider

 

As markets have developed throughout time, investment firms have strived to suit all of their customers' needs by creating new and inventive funds and indexes. 

 

As a result, several investment firms are collaborating with specialized index providers or developing their own proprietary indexes for use in passively managed funds. Tracker funds now have a considerably broader definition as a result of the market's evolution.

 

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Customized indexes for market segments, sectors, and themes are now available in passively managed tracker funds. In addition to typical growth and value index strategies, tracker fund strategies also include indexes vetted for a variety of features and fundamentals.

 

Customized tracker funds aim to replicate the performance of a predetermined market index, but they allow for far more precise investment. 

 

They are able to keep total fund expenses low by continuing to use an index replication method while gaining many of the benefits of active fund management through screened indexes, resulting in relatively cheap costs for investors.

 

When a customized index reconstitutes, which happens once a year, these funds only need to conduct substantial fund transactions. 

 

Customized tracker funds give investors more choices while also removing many of the major obstacles that fund managers have in outperforming the market.

 

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Passive Investment Model

 

Within these funds, the premise is easy. Several investors aim to duplicate the performance of a wide market index or a specific subject within the broad market. These investors would not have the time or expertise to research and build a model portfolio to invest in. 

 

As a result, these tracker or index funds are excellent choices because they perfectly replicate a specific index. Changes in the index's composition will be reflected in these funds immediately. 

 

As a result, it becomes a realistic choice for individuals who want to invest in the financial markets in a passive manner.

 

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Many investment firms are collaborating with index providers or developing their own proprietary indexes for passively managed funds. The customizable market segment, industry, and topic indices are now included. They still strive to track a predetermined market index, but they offer a more targeted investment.
 

Diversification without the complication

 

Diversification is a topic that tracker funds give to their investors. Consider investing in a Nifty50 tracker fund. About 50 different equities would be held in this tracking fund. While the performance of individual stocks may fluctuate over time, an investor can mirror the index's performance by investing in a fund that holds all of them. The basic goal of diversification is to ensure that the value of the portfolio is not unduly connected with the fortunes of a single index business.

 

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Lower Charges

 

The tracker funds have lower fees as well. The management fees that the fund manager would get on an annual basis would have been included in an actively managed fund. 

 

Because the fund manager strives to outperform the market, these charges are usually higher in an actively managed mutual fund. 

 

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To beat the benchmarks, these actively managed mutual funds make numerous purchases and sales of stocks, which raises turnover costs. While tracker funds are merely required to replicate their specific index, they incur very minimal expense in terms of management. 

 

The turnover costs will also be lower because the fund will only be changed when the larger market index that the fund is tracking changes.

 

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Bottom Line

 

In conclusion, tracker funds are a beneficial investment option for investors. These funds allow clients to invest in broader market themes and indices, which helps investors manage risk by providing an ideal level of diversification while also lowering fund fees. 

 

In the long run, investors should consider tracker funds as a longer-term investment option. It is difficult for actively managed mutual funds to outperform benchmarks. There are numerous top tracker funds on the market where one can put one's money for passive compounding growth.

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