Vodafone's recent record losses should focus investors' minds on the dangers of FTSE trackers and other heavily benchmarked funds, financial experts say.
At first glance, trackers can seem an ideal way to invest in the stock market because few UK equity funds manage consistently to outperform the FTSE All Share Index. Investment Management Association research shows that in rolling three-year periods over the last 20 years, only 35 per cent of actively managed funds, on average, managed to beat the All Share Index. Over the last three years, the figure is 44 per cent.
But investing in those funds that do manage to beat the index in the longer term can be significantly more rewarding.
Over the past 10 years, the top 20 funds in the UK All Companies sector, on average, turned £100 into £349 (€506), which compares favourably to the FTSE All Share at £208.
The bottom 20 funds in the sector returned £141 on average, showing the importance of picking winners rather than losers when choosing actively managed funds.
The problem with tracker funds is that the FTSE - especially the FTSE 100 - is overwhelmingly slanted towards the corporate giants such as Vodafone, so investors in tracker funds are inevitably having their investments skewed and are not getting sufficient diversity for their money.
Adviser Justin Modray at BestInvest says it is an issue that investors continually fail to address. "I think most investors are blissfully ignorant that the FTSE indices are weighted, so are unaware of the increasingly concentrated nature of the FTSE All Share Index," he says.
The largest 10 companies comprise about 45 per cent of the index and the energy, financial and telecommunications sectors dominate it, so price movements in these shares or sectors can have a significant impact on the value of tracker funds.
The FTSE All Share comprises about 80 per cent FTSE 100, 17 per cent FTSE 250 and 3 per cent FTSE Small Cap.
Investors who hold a tracker should also pay close attention to costs. These are measured by the so-called total expense ratio, which mainly consists of the manager's annual charge. Total expense ratios are usually 1-2 per cent. Large funds usually have lower total expense ratios, while those that invest overseas have higher ones.
The Fidelity MoneyBuilder UK Index fund has a total expense ratio of just 0.3 per cent, which makes rivals such as the Virgin Money UK Index Tracking Trust, at 1 per cent, look decidedly expensive.
If Virgin customers moved their money to the Fidelity fund, they would collectively save more than £15 million a year.
Modray says trackers can still play a role in portfolio planning, but it is foolish to view them as one-stop solutions because of the lack of diversity.
"The key to successful longer-term portfolio performance is holding a sensible balance of investments," he says. "This means getting exposure to asset types and sectors which a tracker just cannot achieve in isolation."
John Bentley, a day trader from Surbiton in Surrey, who self-selects shares and funds for his own investment portfolio, is unconvinced about the merits of tracker funds.
"It is true that a lot of managers fail to beat the index year-in, year-out so arguably, trackers can still act as a nice counterbalance to a broader portfolio," he says.
"But I still think that there are plenty of funds, that, if you look at performance records, put tracker funds to shame."
He adds: "If you asked me whether I would rather invest in Derek Stuart at Artemis, Anthony Bolton at Fidelity, Nigel Thomas at Framlington or in a tracker fund, I think the answer is pretty obvious."
Bentley feels trackers attract a lot of money because they are seen as an easy option by investors and have the added advantage of having lower charges than actively managed funds.
"I think the charges issue is a red herring," he says. "You pay for what you get. If an active manager provides stellar growth then I don't think charges even enter into the equation.
"True stockpickers with solid track records have consistently proved their worth over restrictive tracker funds."
