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How to compare index trackers

Ha, ha. So you want to compare a few funds? Prepare for pain my friend, prepare for pain. You’d think there’d be some great app out there that would enable you to match up the key data in the blink of a pixel. But no…

While the flash boys play Tron bikes in cyber space, you and I limp along the information B-roads on our tuk-tuks. Even the best tool – Morningstar’s Fund Compare – is as clunky as a 1980s mobile phone, and only enables you to compare Open Ended Investment Companies (OEICs) and Unit Trusts.

To compare Exchanged Traded Funds (ETFs) as well as funds, try Funds Library’s Data Comparison1 and fold in extra data from Morningstar.

I’ll explain how to do so as we go.

Looking inside an index tracker

Comparison able

Once you’ve condensed the universe of possible funds into a solar system of probables, feed your choices into Fund Compare or Data Comparison and face-off the following:

Expenses as measured by Total Expense Ratio (TER) or Ongoing Charge Figures (OCF)Lower is better.

Number of holdings – Higher is better. More securities equals more diversity and less chance that you’re taking unrewarded risk.

Average market cap – If you want exposure to small caps then obviously a fund that holds smaller sized companies is better.

Search for your tracker on Morningstar. Click through to its profile and you’ll find average market cap on its Portfolio page.

Fundamentals – To increase exposure to the value factor, compare your trackers on the key ratios:

    • Price/earnings
    • Price/book
    • Price/sales
    • Price/cash flow

As a rule of thumb, the lower the number, the greater the trackers’ exposure to value.

Each fundamental measure amounts to a different method of identifying value. Investments will vary in their exposure to each fundamental and this accounts for short-term performance differences. But those transient advantages have levelled out over time, so don’t sweat it.

If the fundamentals don’t reveal a clear winner then plump for price/book as your tie-breaker, because it’s the most widely used factor.

To find fundamental data: search for the tracker on Morningstar. Click through to its profile and you’ll find the fundamentals listed on the Portfolio page.

Turnover – Lower is usually better. A low-trading fund racks up fewer dealing expenses.

You can compare turnovers using the Funds Library Data Comparison tool.

Bid-offer spread – Another cost of trading that affects Unit Trust funds and ETFs. Sometimes the spread can be so large that you may be better off with a higher OCF product.

A tracker’s buy/sell prices will be available on its website. Calculating the bid-offer spread is straightforward.

Tracking error – Lower is better as it means the fund’s costs are consuming less of the market’s return.

It’s tricky to make accurate tracking error comparisons across products, but we’ve previously explored two ways to measure tracking error, using Hargreaves Lansdown’s and Bloomberg’s charting tools.

Performance – Sure, higher is better but asset classes rise and fall like empires. Today’s sick man could well be tomorrow’s dominant power.

Look for the annualised return in the Total Returns section of a product’s Morningstar profile and pay no heed to less than five years worth of data.

Sharpe ratio – Higher is better. The Sharpe ratio is a risk-adjusted measure of investing performance. It enables you to compare whether the risk taken is worth the return. A ratio of 1 is good, 2 is very good and 3 is excellent.

The factsheets of life

It’s rare that one tracker trounces another in any comparison. These are the ultimate me-too products, after all.

I normally err on the balance of advantages, but if you only want to bother with one data point then pick the OCF every time.

Index tracking has become an increasingly competitive space, with little opportunity for product providers to open up yawning advantages.

So while it’s sensible to understand the important features of trackers and how to read a factsheet, picking the ultimate product is nowhere near as important as sticking to a passive investing strategy and choosing the right asset allocation.

Take it steady,

The Accumulator

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{ 33 comments… add one }
  • 1 Neverland July 8, 2014, 9:32 am

    Or just buy a Vanguard world stock market etf with a TER of 0.17% a year…

    http://www.bloomberg.com/news/2014-07-07/how-to-cut-fees-and-simplify-your-portfolio-with-one-move.html

    At the moment I am using five Vanguard ETFs based out of Europe for my equity component but this US based etf would make things real simple, provided taxes don’t get in th way

    Obviously the cost of dealing will be a bit higher for an overseas share, but I think thats manageable as I don’t trade more than once a year

    Anyone know how taxes on US etfs work inside and outside ISAs?

  • 2 woody085 July 8, 2014, 10:02 am

    1 year tracking data from FE Analytics (this trend bears out across most assets). Cost, although important should never be the core consideration.

    Vanguard UK Equity Index: tracking error 0.03%, net excess return -0.11%
    Blackrock UK Equity Tracker D: tracking error 1.85%, net excess return -0.6%
    HSBC UK All Share Index C: tracking error 1.89%, net excess -0.65%
    Fidelity Index UK A: tracking error 1.95%, net excess return -0.81%
    L&G UK I Index: tracking error 1.95%, net excess return -0.98%

  • 3 Oliver July 8, 2014, 10:11 am

    In terms of the ‘value’, isn’t market cap weighting an inherent problem, if you’re giving apple, google etc bigger weightings in the tracker. I imagine trading costs of rebalancing an index would make keeping an equal rated index rather expensive, though.
    Just comparing a couple of ftse 250 (which is naturally less concentrated/weighted) trackers to 100 equivalents expense ratios are higher but value/returns are higher, too.

    Not entirely sure where I’m going with this, perhaps it’s better to hold separate 100 and 250 trackers over an allshare/350 tracker, as the index is so heavily weighted by the large cap companies. and/or use an equal weighted index tracker (these seem to be easier to find on the s&p 500 than ftse)

  • 4 David July 8, 2014, 10:19 am

    Interesting article as I’m about to do the same as I transfer my discretionary SIPP to a few low cost trackers. Not sure I agree with OCF as the main consideration for global trackers; the difference in returns for global trackers is huge and swamps any small differences in cost. For non global trackers I agree its the right way to go

  • 5 The Escape Artist July 8, 2014, 12:47 pm

    This is a helpful article. My view is that its really important not to get lost in the minute details of tracking error, Sharpe ratios and other quantitative measures. The most important consideration, alongside cost, is the incentives and ethics of the fund provider. Vanguard are unique by virtue of their mutual ownership model and the philosophy of founder Jack Bogle. So for me the only questions are: which index or style do I want to track and then which Vanguard fund or ETF best does that?

  • 6 David July 8, 2014, 12:52 pm

    Seriously now thinking of putting 85-90% in Vanguard 80% equity and keep around 10-15% as a satellite for fun/opportunistic plays.
    Has anyone done this?

  • 7 Jon July 8, 2014, 3:30 pm

    @Neverland, I haven’t done a detailed comparison but VWRL (FTSE All World) is UCITS compliant, could be an alternative option.

    @Escape artist, David, call me paranoid, but I would never sink all my hard earned wealth into just one fund company. The ETF portion of my portfolio is spread around evenly amongst I shares, SPDR and Vanguard.

  • 8 David July 8, 2014, 3:36 pm

    Jon,
    Thanks, I’m also a little nervous about putting 85% with Vanguard, but this is a gut feel and I’m not sure exactly how the risk could manifest itself. The attractions of (relatively) low cost, outperformance vs sector and automatic rebalancing are very tempting.

  • 9 Kean July 8, 2014, 5:14 pm

    Hi TA,
    I have attempted to register for Fund Library’s Data Comparison before and tried again today. The registration page and their Ts & Cs state “Funds Library is solely for the use of professional data users and is not available to private investors”. I therefore assumed that as a private investor, I could not access this site. Am I missing something?

  • 10 The Accumulator July 8, 2014, 6:29 pm

    @ Woody – one year tracking data is not reliable. Moreover, I’ve had problems getting consistent results out of FE before. What criteria are you using?

    @ Neverland – using a US based ETF is not the way to make life simpler. Try a LifeStrategy fund or VWRL instead.

    @ David – if your tracker choices track the same index and their costs are similar then the differences in return over a decent period of time are unlikely to be huge, else the bad tracker is going out of business.

    @ Kean – yep, just fill in the registration and you’ll find it fairly easy to elude their defences 😉

  • 11 woody085 July 8, 2014, 9:19 pm

    Accumulator. I have simply filtered based on net excess and tracking error over 1 year to show the figures for all passive funds. I analyse this data regularly and it seems to be consistent to me. I know Vanguard provide accurate data to Analytics. Here is the 5 year annualised data:

    Vanguard – tracking error 0.07%, excess return -0.17%
    L&G – tracking error 3.15%, excess return -1.79%
    Fidelity – tracking error 3.16%, excess return -1.54%
    Blackrock – tracking error 3.18%, excess return -0.81%
    HSBC – tracking error 3.35%, excess return -1.2%

    During this time Vanguards performance is approx 5% better than Fidelity. Their cost reduction from 0.3% to 0.07% will not compensate for this inferior performance.

    Vanguard US Equity TE is 0.53% and ER -0.19%
    Blackrock US TE is 4.25% and ER is -0.71%
    Over 5 years Vanguards performance is 10% better than Blackrocks (136% compared to 123%)

  • 12 neverland July 8, 2014, 9:49 pm

    @ Accumulator, Jon

    The European VDRWL has a TER of 0.25% and my devils brew of Vanguard etfs currently has a average TER of about 0.16% per annum plus maybe £30 pa in dealing fees for the rebalancing I would otherwise not have to do every year

    I reckon I’m saving c. £300 a year over VDRWL’s fees which is worth having. In ten year’s time (fingers crossed) that annual saving could easily double in value in real terms, so thats an iphone contract or a gym membership taken care of then

    If VDRWL had the same TER of 0.17% its equivalent over the pond did I would switch over to that

  • 13 David July 9, 2014, 12:22 am

    Thanks Accumulator, my comments on risk are more to do with things like counterparty risk etc as I believe Vanguard loans stock to shorters which presumably is the way they beat some indices. I’m trying to decide if it’s safer to split the investment across multiple ETF providers

  • 14 grey gym wock July 9, 2014, 12:23 am

    AIUI, you will lose on tax by holding a US ETF in an ISA or unwrapped, because 15% tax will be withheld on dividends – which is no change for dividends from US companies, but is an additional 15% for dividends from non-US companies. US ETFs can be a better idea in a SIPP, where (with some SIPP providers) there is no withholding tax applied.

    then there are currency conversion costs when buying/selling a US ETF – which vary a lot for different brokers, but can be very expensive.

  • 15 Neverland July 9, 2014, 8:08 am

    @ sock

    Tax – remembered vaguely there was potentially some withholding tax issue so I guess losing 15% of the 50% of the income from the non US companies is the thing that kills it, thanks

    Exchange rate risk – I don’t agree with you about the exchange rate thing but I only buy once a year and I’m not really planning on selling ever

    I will have to find another way to be cheap

  • 16 David July 9, 2014, 10:40 am

    Just found this:
    http://jlcollinsnh.com/2012/09/07/stocks-part-x-what-if-vanguard-gets-nuked/
    for those worried about tying up all your dosh with 1 providor

  • 17 The Escape Artist July 9, 2014, 11:44 am

    David – Yes, thats a good Jim Collins post on why some intelligent people are comfortable putting all their eggs in one basket….as long as the basket is chosen and watched carefully. Also see Warren Buffett’s recent advice to put 90% into a single Vanguard fund:

    http://www.berkshirehathaway.com/letters/2013ltr.pdf

    Even if Vanguard goes bust, the client funds should be segregated.

  • 18 weenie July 9, 2014, 11:48 am

    @ David – thanks for posting the link. I’m gradually switching more of my funds into Vanguard. Hoping to dump most into Vanguard LS 80%.

  • 19 grey gym sock July 9, 2014, 1:34 pm

    re currency conversion costs (not exchange rate risk, which is something else) …

    supposing you will never sell, then the choice (if we pretend the tax issues don’t exist) is between paying 5 dealing commissions a year (to top up 5 european-based ETFs), or paying 1 dealing commission a year (to top up the US ETF) + whatever percentage you pay to convert sterling to dollars (before buying the US ETF). i’d be surprised if you can do the currency conversion for less than the cost of 4 dealing commissions.

  • 20 Neverland July 10, 2014, 9:04 am

    @sock

    Exchange rates/currency conversion costs, you tell me?

    I’ve not dabbled my toes into holding foreign listed shares. How much is the “currency conversion fee” with your broker and which one is it?

    The US witholding tax tax makes the whole “switching to US Vanguard etf” thing unattractive but I’m genuinely interested in the cost of investing in non-UK available etfs in general, e.g something that might only be listed on a European exchange, like Dublin or Luxembourg

  • 21 grey gym sock July 11, 2014, 1:42 am

    for instance, youinvest charge 1% for currency conversion every time you buy or sell (so 2% for the round trip); though only 0.5% to convert non-sterling dividends back to sterling.

    iweb (who are otherwise so cheap) charge 1.5% for currency conversion.

    HL charge 1.7% to convert small amounts, but less on larger amounts, on a sliding scale going down to 0.35%.

    i think many brokers charge more than 1%.

    none of the above brokers allow you to hold cash with them in other currencies. this is not allowed in ISAs anyway, according to the ISA regulations. in non-ISA accounts, it could be useful to have (e.g.) a $ cash account with a broker, because

    (a) you could sell 1 security traded in $, and then buy another, without converting to £ and then back to $ (though this is not so important for buy-and-hold passive investors); and

    (b) some brokers also allow you to transfer cash into your $ account with them from an external account, which can be a way to do the currency conversion with somebody who gives you a better rate than the broker does.

    e.g. apparently TD direct don’t have great currency conversion rates, but do have multi-currency accounts, and allow you to transfer in cash in a foreign currency.

    interactive brokers apparently have multi-currency accounts, and very cheap currency conversion. however, they charge a minimum dealing commission of $10 per month (i.e. an inactivity fee if you don’t deal).

    another point to note is that many ETFs which are traded in sterling actually pay dividends in another currency. when this happens, your broker will already be charging you to convert the dividends back to sterling. from what i’ve seen, unless most of an ETF’s income arises in sterling, it will typically pay dividends in either euros (if that’s how most of its income arises) or dollars (in all other cases). (there has been some discussion of this on both MSE and TMF).

  • 22 Kean July 11, 2014, 8:17 am

    @ GGS, very informative re currency conversion. Just started to invest in non-UK EFTs/Tracker funds so helpful pointers – thanks.

    Like-like comparison of broker/platform providers is pretty much impossible unless you are clear about how you intend to use their services and stick to that plan come what may. Something I have not managed to do so far because needs/wants change – that is life!

    Seems to me if they don’t get you one way, they will in another. Service providers have to make profit – understand that completely but wish it was easier to use/exit their services without paying the nose for the privilege. THEN again, guess that is just the whole point – confusion creation approach 🙂

  • 23 Rob July 11, 2014, 9:40 am

    The quickest way to compare trackers is is to use HL’s list of tracker funds.
    http://www.hl.co.uk/funds/index-tracker-funds/view-index-tracker-funds

    It has a few gaps but covers most of the important measures.

    One simple, but often overlooked, measure that can be used to compare funds is yield. All else being equal, which it rarely is but even so, a fund with a higher yield will have a larger bias to value than one that does not.
    It also gives an indication of how much of the fund consists of derivatives or synthetics as they don’t pay dividends.

  • 24 Living Cheap In London July 11, 2014, 1:19 pm

    I’ve been moving more into Vanguard Lifestrategy 80% over the last year.

    Still a chunk of cash in various individual stocks, but i think that will be less & less going forward. It’s just easier & leaves me time to enjoy the rest of life.

  • 25 Kean July 11, 2014, 4:29 pm

    TA, are there any simple guiding principles in choosing between ETFs and tracker FUNDS for target area/sector. For example, Vanguard All-World (VWRL) and Vanguard FT Developed World ex UK.

    I am sure there are some differences in the composition of the underlying investments in both but on the whole looking for all-world and trying to figure out which version (ETF or Fund) would be more cost effective and easier to manage longer term. Are you able to kick-start my decision making on this?

  • 26 grey gym sock July 11, 2014, 8:37 pm

    i’m not TA, but …

    for ETFs, you’ll always be paying dealing commission to buy or sell, so for smaller amounts invested, you’re better off using funds, and a platform which doesn’t charge for dealing in funds (and instead charges a small % on funds held). for larger amounts invested, you’re better off with a fixed-cost platform, which may then have the same charges for using funds and ETFs, so there’s less difference. see http://monevator.com/compare-uk-cheapest-online-brokers/

    continuing the point about currency conversion, i think you avoid that issue with funds. all the ones aimed at UK investors (whether domiciled in the UK or ireland) seem both to be bought and sold in sterling, and to pay dividends in sterling. (perhaps because these funds are *only* aimed at UK investors, but ETFs are usually aimed at investors in multiple european countries.)

    do you prefer a tracker which distributes income, or automatically reinvests it? most funds give you a choice of income or accumulation units; most ETFs only have distributing shares. though there are exceptions for both. (1 advantage of an accumulating ETF could be to avoid the currency conversion costs on non-sterling dividends.)

    there is generally less investor protection with offshore funds or ETFs – see http://monevator.com/investor-compensation-scheme/ . just about all ETFs seem to be offshore, but fewer funds are.

    synthetic ETFs are a rather different beast, with no equivalent in funds. physical ETFs and funds work in a similar way to 1 another (i.e. they actually buy the underlying investments).

  • 27 Rob July 12, 2014, 9:47 am

    ETFs are complex beasts for a variety of reasons. Take this ETF that has an advertised TER of 0.4% on the £521m it runs. The fund has costs of £1,968,000 but on top of that it incurs a finance cost of £7,000 and £246,000 of realignment costs. This item is not explained but is essentially the cost of the derivative transaction that underlying the fund. Then there is £88,000 of tax but that is balanced by £83,000 income from securities lending. That takes the total cost charged to the fund of £2,392,000 equivalent to 0.46%.
    Still low, but obviously the fund is quite different from a simple long only buy and hold fund.

  • 28 The Accumulator July 12, 2014, 2:22 pm

    It’s hard to tell, but there may be some confusion setting in here.

    Old Grey Gym Sock is giving guidance on ETFs available through foreign exchanges e.g. US ETFs on the NYSE.

    That’s different from ETFs that track non-UK markets e.g. the S&P 500 but are domiciled in Dublin or Luxembourg. ETFs like that trade on the London Stock Exchange and you won’t pay currency conversion costs to buy and sell them.

    @ Kean – this piece may help: http://monevator.com/how-to-read-a-fund-fact-sheet/

    In the example you cite, VWRL has exposure to emerging markets and the UK whereas the Developed World ex UK fund doesn’t. Therefore as a one-shot fund that maximises diversity and minimises trading costs (because you don’t need to buy separate funds to own the UK for example) then VWRL wins. You just have to be happy with the asset allocation VWRL offers, although you could always buy another fund to increase your allocation to a particular market e.g. the UK if you wished.

    When comparing indices, it’s a good idea to look up the factsheets to get a feel for composition. A good index is as broad and diversified as possible and not dominated by a handful of mega stocks. See the link for more.

  • 29 grey gym sock July 12, 2014, 4:46 pm

    i’ve probably been packing too many different ideas into these comments – unlike the articles on monevator, which are so good at laying out 1 point at a time!

    as TA says, the ETFs which UK investors are likely to use (unless we’re trying to be too clever :)) are ones which can be bought and sold in sterling on the london stock exchange, without paying currency conversion costs. and they can invest in all parts of the world – as VWRL does, for instance.

    however, some of these ETFs do pay dividends in other currencies. e.g. VWRL pays dividends in dollars. your broker will automatically convert the dividends to sterling, at a cost.

    suppose the yield on VWRL is 2%, and your broker charges 0.5% to convert the dividends; that will cost you an extra 0.01% per year (because 0.5% of 2% is 0.01%). or, if your broker instead charges 1.5% to convert the dividends, that will cost an extra 0.03% per year.

    these are small numbers, but you can add them into the effective on-going charges for holding VWRL. its basic on-going charges are 0.25%, so after adding currency conversion costs you could have 0.26% or 0.28%.

    this is of some (tiny) relevance when comparing VWRL to the vanguard developed world ex-UK fund. the latter has on-going charges of 0.30%, and it makes distributions in sterling, so there is nothing to add to that figure for currency conversion.

  • 30 The Accumulator July 12, 2014, 7:13 pm

    Spot on. Many thanks for your helpful comments Old Grey GS

  • 31 Kean July 15, 2014, 7:55 am

    TA, was asking about ETFs & tracker funds because I want to develop my own guiding principles for consolidating my investments which have been too diverse. Given general wisdom re diversification, it may have been a wrong thing to do to hold such a wide range but there was a method in my madness – discussion for another time perhaps!

    Your discussion leads have been very helpful in developing my own guiding principles. I agree with @GGS that you are very good at zooming in on one point & unpeeling the layers. I now have a full set of my own guiding principles. 🙂

    Thanks also for the factsheet link – did read it the 1st time you published it but need to go through it again.

    @ GGS & Rob … Thank you for the pointers; certainly crystallised my thoughts.

  • 32 Ant August 11, 2014, 4:09 pm

    I read somewhere that you should check that trackers use ‘full replication’ of the index tracked. May I ask, is this a critical factor when chosing trackers and where can the information be found?

  • 33 The Accumulator August 12, 2014, 9:45 pm

    Hi Ant, you can find that information on the fund’s factsheet. Full replication is ideal but not critical. Certain indices are too costly to replicate in full so products will generally sample the relevant market (i.e. select a representative subset of the index rather than every single stock). Products that do this will often refer to ‘optimised replication’. The more stocks they use the more faithful the tracker. Here’s an article you may find useful: http://monevator.com/how-to-read-a-fund-fact-sheet/

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