Choose your tracker fund very carefully

Passive funds will usually fall slightly behind the total returns of the benchmark they follow due to the impact of fees. And high costs partly explain why five UK passive funds have underperformed their benchmarks by over 4 per cent in three years - in one case by 9 per cent.

The choice of the cheapest, and most up-to-date share class is key when choosing trackers but those invested via pension funds might unknowingly be invested in old, expensive share classes that pull back their returns.

Shaun Port, chief investment officer at Nutmeg says: “The issue with the majority of these trackers is that they are charging extremely high fees to track their benchmarks. Whilst most investors consider trackers low cost ways to access the market, they may not understand the true extent of the fees they are paying for some products.

“We have seen many examples of this sort of thing in the past and it is particularly prevalent in the life, pension and onshore bond sectors where pricing is tied to the investment structure.”

Adrian Lowcock, head of investing at AXA Wealth says: "Several funds look like legacy funds which are not necessarily widely available to investors."

The worst-performing passives fund in Chelsea’s list was Family Charities Ethical (GB0005782627), which lagged its FTSE4Good UK 50 index benchmark by 9 per cent over three years. Its accumulating share class carries an ongoing charge of 1.49 per cent which includes an annual management fee of 1 per cent, which has taken a toll on returns.

Mr Lowcock says: "This tracker fund is charging an active manager like fee and over three years this should account for around 4.5 per cent of under performance.

However, he says that the consistent annual loss of 3 per cent over the last few years suggests that underperformance could be down to other issues such as the poor use of derivates to reduce tracking error.

Of the other poor performers, Family Asset Trust (GB0003315511) lagged behind its FTSE 350 ex investment trust index benchmark by 4.7 per cent over three years and the Class 1 version of Aviva UK Index Tracking Fund (GB0004459797) underperformed the FTSE All Share by 4.3 per cent in the three years to May and has an ongoing charge of 0.92 per cent. Meanwhile, L&G (N) Tracker Trust (GB0008468174) underperformed the FTSE All Share by 4.1 per cent over three years, in part due to its 1.15 per cent ongoing charge, which would result in fees of 3.45 per cent over three years.

L&G (A&L) Capital Growth is also in Chelsea's list. But along with the bulk of the worst performers, it is a legacy fund which carries now out-of-date cost structures. A Legal & General spokesperson said it was a "legacy fund" and "currently under review" and added that L&G's new, lower-cost 'unbundled' share classes, carried lower fees and tracked better than old share classes. The L&G UK index (GB00B0CNH502) available on platforms underperformed the FTSE All Share by just 0.72 per cent over three years.

Not all the funds in Chelsea’s list are bad performers, with some tracking predominantly well. The low-cost HSBC FTSE 100 Index Fund (GB00B80QFR50) underperformed its benchmark by just 0.2 per cent, partly explained by its ongoing charge of 0.17 per cent. CAF UK Equitrack (GB00B02TV349) underperformed its FTSE All Share index benchmark by just 0.60 per cent and carries an ongoing charge of 0.32 per cent.

The cost of UK trackers is coming down all the time, making the best performers even tighter trackers. Good options include The Vanguard FTSE 100 UCITS ETF (VUKE), which offers access to the FTSE 100 for just 0.09 per cent and the Vanguard FTSE UK All Share Index Unit Trust (GB00B3X7QG63), with an ongoing charge of just 0.08 per cent.

Worst-performing passive funds

Source: Chelsea Financial Services, based on Trustnet data.