What is a tracker fund?

Index funds (also called tracker funds) aim to closely track the performance of an index (such as the FTSE 100) by investing in companies within that index.

They are 'passive' funds, which means they are not actively managed - they simply follow the performance of the investments in the index. They are often cheaper to buy than 'active' funds, which have a fund manager selecting investments.

• Active versus passive: learn about the pros and cons of each

Why invest in index tracker funds?

• Take a more ‘hands off’ approach to investing.
• Easily invest in entire markets, indices, regions and sectors.
• Reduce risk through diversification.
• Lower the cost of building a diverse portfolio.
  

How index tracker funds work

Index tracker funds aim to either fully or partially replicate the investments within an index.

Full replication

The investments within an index are mirrored using a very similar weighting. For example, a FTSE 100 tracker fund would invest in all 100 companies, using their weighting within the FTSE 100 to determine representation.

Partial replication

Not all of the investments in an index are held, as it may be costly to invest in the smaller constituents. Investments are chosen to represent industry sectors, for example, if the financial sector represents a quarter of the FTSE All-Share index, approximately 25% of the tracker fund would be invested into a selection of financial companies that will best replicate the sector's performance.

Things to bear in mind

• Tracker funds will follow index performance up and down.
• If an index is heavily weighted to a particular sector or region, these will have a greater impact on performance.
• The tracking error can be distorted due to the difference in the valuation point of the fund and the index it tracks.
• Some fund managers engage in stock lending, involving higher levels of counterparty risk.
  

How to invest in index tracker funds

Learn more about investing in tracker funds with ii.

Help choosing tracker funds

There are lots of tracker funds out there, so let us help you choose. Our Super 60 investment list includes several tracker funds to choose from, carefully selected by our experts.