More investors are choosing tracker funds as a price war in the passive funds industry drives down costs ever further. Sales of funds that track a market index have more than doubled in the past five years according to Investment Association (IA) figures, which showed a rise from £2.5bn in 2011 to £6.7bn at the end of 2015. Assets under management for the sector also increased from £60.4bn in 2012 to £107bn at the end of 2015, but this figure reflects market performance as well as investor demand.
Despite the increase, assets under management in tracker funds are still dwarfed by those of actively managed funds, accounting for just 12.1 per cent of assets under management in UK-authorised unit trusts and open-ended investment companies, and some recognised offshore funds.
The popularity of tracker funds is being driven by a price war in the passives industry, which has seen costs slashed from previous levels, according to Danny Cox, chartered financial planner at Hargreaves Lansdown. But he warned that too many investors are still paying high fees for poorly managed active funds.
"There's still a huge amount of money in funds that underperform," he said. "[But] investors are also becoming much more savvy. The market is dividing. At one end of the scale you've got ultra-low-cost passive funds and at the other you've got very good, high-quality active managers, and in the middle there's a whole bunch of stuff that doesn't really add a huge amount of value."
He believes this polarisation of the market will eventually crowd out closet trackers - actively managed funds that consistently fail to beat their index - as investors seek out real value in both active and passive funds.
Hargreaves Lansdown has also seen an increase in the number of its clients buying passive funds, up from 6.1 per cent in 2011 to 11.2 per cent in the year to date. It has recently added 13 index trackers to its favoured funds list, the Wealth 150+, in recognition of trackers' growing importance to private investors.
Other platforms have also seen changes. Analysis by rplan.co.uk showed gross inflows into tracker funds up by 248 per cent between 1 July and 11 August 2016, compared with the same period last year. "The evidence points to investors' growing awareness of costs and the extent to which they now question the value added by active managers," said Stuart Dyer, chief investment officer at rplan.co.uk.
But investors should be careful about which markets and asset classes they use passive funds in, says Jason Hollands, managing director at Tilney Bestinvest. His research found 74 per cent of actively managed funds in the UK All Companies sector have beaten the FTSE All-Share index over the past five years.
"In UK equities, trackers have been a terrible place to invest over the past few years," he said. "It's ironic that you've had a huge increase in interest in index trackers over a period where the vast majority of active fund managers have done a better job."
The reason active funds have performed better than trackers is due to their greater exposure to mid-cap stocks, which have generated strong returns in the past few years, added Mr Hollands.
Meanwhile, Darius McDermott, managing director of FundCalibre, warned that the UK stock market bounce that has followed the Brexit vote could make using tracker funds riskier.
"Now is not the time to buy a market tracker," he said. "The recent surge is making the indices look expensive and you risk buying right as we are on the cusp of renewed volatility."
But the US stock market is a much harder market for active managers to beat as it is highly efficient. This means relevant information on companies is equally accessible to investors so that stock prices respond immediately to available information. Recent data revealed 90.2 per cent of actively managed US mutual funds that invest in domestic equities were beaten by their benchmarks when their returns were calculated net of fees.
For this reason, Mr Hollands tends to use trackers such as HSBC American Index Fund (GB00B80QG615) when investing in US equities.
