Choosing cost-effective funds is almost as important as picking ones which perform well, because high costs can eat into your returns, and in the case of an individual savings account (Isa) negate any of the tax benefits. For this reason using low-cost passive funds such as trackers and exchange-traded funds (ETFs), which track indices and assets, to construct your Isa portfolio can be a good option, especially as many active funds fail to beat markets consistently over the long-term.
However, even within the universe of low-cost passive funds there are considerable price variations, so you should not opt for the first one you see, especially as there is even less excuse to charge over the odds with a passive fund.
With this in mind we have set out some of the cheapest trackers and ETFs in the five main investment areas which are eligible for inclusion in Isas. We have set out a few options in each because the cheapest option is not necessarily the best - if a fund has a high tracking error, eg underperforms the index it is supposed to be tracking by quite a bit, you may be better in the long-term with slightly higher charges and closer replication of the index's returns.
Also make sure that these funds are available via your Isa wrapper, and if it would be worth transferring to an Isa in which you can hold the fund, as some Isa providers levy a penalty if you transfer out, while some Isas may have charges such as an administration fee.
There is also a major difference between tracker funds, which are open-ended funds such as open-ended investment companies (Oeics), and ETFs which are listed on a stock exchange like a share. You tend to be able to buy trackers from platforms or even the provider without an initial fee, leaving you only to pay the other fees.
ETFs, by contrast, have to be bought from a stock broker so in addition to the costs the total-expense ratio (TER) sets out, you have the broker's charge, which typically varies between about £10 and £30 a trade.
You will need to decide which way is most cost effective for you, if you find that the ETF option has the lower TER. A brokerage fee may work out less than a higher TER, and if you aim to hold the ETF in your Isa for a long time rather than continually trade, a one-off brokers fee could be preferable to higher fees every year.
FTSE 100 tracking funds
The cheapest FTSE 100 tracker option is the HSBC FTSE 100 Index fund with a TER of 0.27 per cent and no initial charge, and a good tracking record: over five years annualised it returned 1.7 per cent just short of the FTSE 100's 1.8 per cent, and over three years made 2.2 per cent while the index fell 0.3 per cent. Trackers can outperform indices for a number of reasons, for example, their managers can make money by lending stocks, so this is an instance where it is acceptable for your fund not to track accurately.
The next cheapest tracker is Liontrust Top 100 which has a TER of 0.42 per cent and no initial charge. Over five years it returned 23.59 per cent against 25.77 per cent, and over three years 17.54 against 18.9 per cent. Over one year it made 10.15 per cent against 10.32 per cent for the FTSE 100.
Liontrust Top 100 only has an income share class which pays out dividends rather than reinvesting the proceeds in the fund and boosting growth whereas HSBC FTSE 100 Index fund gives you the option of income or accumulation units.
The cheapest ETF is db X-trackers FTSE 100 which has a 0.3 per cent TER. Since this fund's launch in June 2007 it has returned 2.9 per cent against 3.89 per cent for the FTSE 100. Deutsche Bank ETFs use synthetic replication - they do not buy the shares in the FTSE 100 but buy a swap, so rely on the swap counter party to deliver whatever returns the FTSE 100 makes. Some people consider this higher risk than buying the shares in the FTSE 100 because if the swap counter party, usually a bank or financial institution becomes insolvent, it may not be able to deliver the returns. However Deutsche Bank mitigates against counterparty failure by holding collateral such as low-risk bonds with a value equivalent to at least 90 per cent of the value of the fund, and in most cases equal.
One of the main reasons for using a swap rather than buying the shares, according to providers who do this, is because it can work out cheaper than buying and trading shares in an index. Lower costs should improve the fund's returns but doesn't always.
If you don't want a swap counter party there is the iShares FTSE 100 ETF which buys the shares in the FTSE 100 and has a 0.4 per cent TER. Over the past three years this fund has returned 16.21 per cent against 17.4 per cent for its index, and since its launch in April 2000 31.33 per cent against 38.88 per cent for the FTSE 100.
FTSE All-Share tracking funds
The cheapest option for investing in the FTSE All-Share is the HSBC FTSE All Share Index Fund which has a TER of 0.27 per cent with no initial charge. Over five years annualised it has returned 3.5 per cent against 4 per cent for the FTSE All-Share, over three years 3.5 per cent against 1.5 per cent and over one year 14.6 per cent against 14.4 per cent.
Fidelity MoneyBuilder UK Index has a TER of 0.3 per cent and no initial charge. The fund has delivered growth well ahead of the FTSE All-Share over three and five years returning 13.8 and 20.7 per cent respectively, against 13.7 and 24.1 per cent for the FTSE All-Share. Over one year the fund returned 17.5 per cent while the index delivered 18.1 per cent.
The Vanguard FTSE UK Equity Index Fund is an all share tracker with a very cheap TER of 0.15 per cent. However, there is an additional 0.5 per cent cost to cover Stamp Duty Reserve Tax which is levied when UK stocks are bought and the shares of a fund investing in UK stocks are redeemed. Most funds either account for this via the TER or include it within the fund, which obviously eats into returns. Vanguard says it asks investors to pay Stamp Duty Reserve Tax upfront so the exact cost to an investment is clear from the outset. As the charge relates to the activity of individual investors, longer-term investors don't subsidise those who invest for a shorter duration.
Vanguard FTSE UK Equity Index fund does not have a long-term record, but certainly since its launch in June 2009 it has incurred a very small tracking error - it has returned 27.51 per cent against 27.72 per cent for the FTSE All-Share.
For ETF exposure, there is Lyxor ETF FTSE All Share with TER of 0.35 per cent. This uses synthetic replication and via a swap, and in this case the counterparty is French investment bank Societe Generale. Its tracking error, the amount by which it has underperformed the FTSE All Share, is 0.07 per cent over the last 52 weeks.
Db X-trackers FTSE ALL-SHARE ETF has a 0.4 per cent TER, though since launch in 2007 this ETF has only delivered 0.69 per cent in contrast to the FTSE All-Share which rose 1.94 per cent.
All Share fund returns
| Index/fund | 11/03/2010- 11/03/2011 (%) | 11/03/2008- 11/03/2011 (%) | 10/03/2006- 11/03/2011 (%) | Total expense ratio (%) |
|---|---|---|---|---|
| FTSE All Share index TR GBP | 8.64 | 16.12 | 20.18 | |
| IMA UK All Companies fund sector | 11.07 | 14.4 | 17.84 | 1.49 |
| FTSE All Share Tracker funds | 7.89 | 14.71 | 17.9 | 0.67 |
| Source: Morningstar | ||||
S&P 500 tracking funds
The cheapest tracker option for the S&P 500 is the HSBC American Index Fund which has a TER of 0.28 per cent. Over five years this has returned 10.9 per cent against 11.5 per cent for the S&P 500 Composite, and outperformed it over three years - 18.7 per cent against 15.8 per cent.
Among ETFs there is a better choice of funds which track the S&P 500, the cheapest of which is the HSBC S&P 500 ETF with a TER of 0.15 per cent. The ETF is less than a year old so there is not much performance data.
HSBC S&P 500 ETF uses physical replication - it buys the shares in the S&P 500.
IShares S&P 500 has a TER of 0.4 per cent and also uses physical replication. Since its launch in March 2002 the fund has closely tracked its index, returning 27.52 per cent against 28.12 per cent for the index. Over three years the ETF has returned 7.04 per cent against 7.14 per cent for the index.
Emerging markets tracking funds
The Legal & General Global Emerging Markets Fund follows the FTSE All-World Emerging Index and has a TER of 0.99 per cent. The fund tracks its index via a representative sample of stocks selected from all economic sectors as Legal & General says successful index tracking strikes a balance between close matching of the index and the management of trading costs. The larger and medium-sized stocks replicate their index weighting within tight tolerances, while smaller stocks are sampled on a random basis to ensure the fund's industry sector weightings are in line with the index. Allocation to large, medium and small-caps is also kept in line with the index.
The fund only launched in October, so there is little performance data to judge it by.
The Vanguard Emerging Markets Stock Index Fund has a TER of 0.55 per cent but also charges a 0.4 per cent purchase fee, and a redemption fee of 0.4 per cent, so the up-front costs of the fund are actually 1.35 per cent. This fund has returned 34.82 per cent since its launch in June 2009 against 35.31 per cent for its index, MSCI Emerging Markets Index. Over one year it has made 21.89 per cent against 22.53 per cent for the index.
Emerging markets ETFs include the db x-trackers MSCI Emerging Markets TRN Index ETF which has a TER of 0.65 per cent. Since its launch in 2007 the fund has returned 10.17 per cent, against 12.73 per cent for its index, the MSCI Daily Emerging Markets TRN Index.
The Lyxor MSCI Emerging Markets Fund also has a TER of 0.65 per cent and over 52 weeks has underperformed its index by 0.134 per cent.
IShares MSCI Emerging Markets ETF has a TER of 0.75 per cent and is available both as a distribution (dividend paying) and accumulation fund. Since launch in November 2005 the fund has matched its index, MSCI Emerging Markets, as both have delivered 94.01 per cent. Over three years the fund has outperformed delivering 9.83 per cent against 8.82 per cent for the index.
Alternative asset trackers
If you wish to invest in alternative assets other than equities or bonds, you will have to look to ETFs rather than tracker funds, as the latter largely focus on mainstream assets.
You can invest in a wide range of alternative assets via ETFs, however these tend to be more complex than equity or bond ETFs and may not always be eligible for inclusion in an Isa, so check this carefully before you invest.
However, ETF Securities offers physical metals funds which have been structured so that they can be held in an Isa. These funds actually own the metal and track the price of it rather than equities or swaps, and with rising inflation could prove to be a useful hedge in your portfolio, as well as a good diversifier to equity and bond holdings. You can buy shares in these funds in much smaller denominations than you could buy metals such as gold, and you do not have to store it.
ETFS Physical Gold has a management fee of 0.39 per cent and is available in sterling as well as US dollar share class, or if you are more bullish on silver ETFS Physical Silver also has a sterling share class and a 0.49 per cent management fee.
If you have concerns on the direction of the price of individual metals, a more diversified and potentially lower risk option is the ETFS Physical PM Basket, which is 45 per cent allocated to gold but also includes silver (29 per cent); platinum (14 per cent) and palladium (12 per cent). The fund has a management fee of 43 per cent and a sterling share class.
