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Passive funds for your Isa

If you're reviewing your Isa investments consider whether you're making the most of passive funds.
March 7, 2014

If you want to keep costs down in your Individual savings account (Isa), buying passive funds is one of the best moves you can make. Used smartly, tracker funds and exchange traded funds (ETFs) are some of the most efficient investments around, and can make ideal core holdings or provide a risk injection for your Isa portfolio.

You can buy passive funds to gain exposure to almost every area of the market for a fee that will very rarely exceed 1 per cent and can be as low as 0.1 per cent. But where should you use them in your portfolio and which funds should you choose? We take a look.

Tracker funds or ETFs?

Tracker funds and ETFs are similar in that they are both low cost investments that aim to track an index of shares. But they are in fact very different investments.

Tracker funds are bought in the same way as actively managed open-ended investment companies and unit trusts. But ETFs are traded on the stock market and can hold assets including stocks, commodities and bonds. If you want to invest in ETFs through your Isa you may have to use a self-select Isa, a service offered by stockbrokers including Barclays Stockbrokers, Halifax Share Dealing and Selftrade. Only a handful of fund platforms offer ETFs: Alliance Trust Savings, Hargreaves Lansdown, Bestinvest, Nucleus, Fidelity, Sippdeal, Sippcentre and TD Direct.

Tracker funds don't incur a trading charge on most investment platforms, while every time you buy an ETF you will incur trading charges. This can become costly if you make regular payments into your Isa rather than a lump sum once a year, so if you are going to do the former you may be better off looking at other types of funds.

 

Check Isa eligibility

Virtually all Ucits compliant ETFs listed in the UK can be put into an Isa, but ETFs listed in the US are not eligible and certain exchange traded commodities (ETCs) listed in the UK are not eligible, either. This is because some of them are not funds, but loan notes. Undertakings for Collective Investment in Transferable Securities (Ucits) are a set of European Union directives which mean collective investment schemes can be marketed throughout the EU whilst maintaining high levels of investor protection.

 

CORE HOLDINGS

UK Equity:

Vanguard FTSE UK Equity Index (ISIN: GB00B59G4893) This is a passively managed fund that tracks the performance of the FTSE All Share Index. It gives you exposure to large, medium and small listed companies with HSBC (HSBA), BP (BP.) and Vodafone (VOD) as the biggest holdings. With a total expense ratio (TER) of 0.15 per cent, this is a cheap-as-chips way to get exposure to UK companies. If you choose an actively managed fund instead you have a chance of beating the index though there are no guarantees. But what is certain is that funds don't get much cheaper than this.

Global ex-UK Equity

Vanguard’s FTSE Developed World ex-UK Equity Index (ISIN: GB00B59G4Q73), is a core holding which is a good diversifier if you've already got a lot of UK exposure in your portfolio, as it excludes the UK. It has a TER of 0.3 per cent.

US Equity

If you're investing in the US, the SPDR S&P 500 ETF (SPX5) comes highly recommended. It tracks the S&P 500 index and has a very competitive total expense ratio (TER) of just 15 basis points a year. This is a significant saving over the ETF's main competitor iShares S&P 500 Index Fund (IUSA), which charges 40 basis points per year and won the Best Exchange-Traded Product for US Exposure category at the IC fund awards in 2012. Like the iShares ETF, the SPDR ETF buys all the underlying shares in the S&P 500 in the correct weightings to mirror the movement of the actual index.

The Russell 2000 index is also worth a look. It provides exposure to a wider range of smaller companies, including many of the technology start-ups that have experienced meteoric rises in recent years. This index is more expensive to track, which leads to higher fees, but analysts say the enhanced performance makes the trade-off worthwhile. Options include db x-trackers Russell 2000 ETF (XRU2) with a TER of 0.45 per cent.

Bonds

BlackRock Corporate Bond fund (ISIN: GB00B5MMQ552). This tracker fund gives you cheap exposure to the global corporate bond market. It invests in a lot of assets which are denominated in other currencies, which means changes in the relevant exchange rate will affect the value of the investment. The fund buys fixed interest securities such as corporate or government bonds which pay a fixed or variable rate of interest (known as the coupon) and behave similarly to a loan. The TER is 0.2 per cent.

If your risk appetite is conservative, take a look at PIMCO's Sterling Short Maturity Source ETF (QUID). It's a very short-term bond fund that seeks to maximise income while preserving capital. It's cheap with a TER of 0.35 per cent and the yield to maturity at present is 0.7 per cent. It seeks to provide a small return over cash after fees without the volatility of equity or corporate bond markets. The focus on shorter-term bonds is important as it reduces the ETF's sensitivity to changes in interest rates, which will go up one day.

Property

For property exposure, BlackRock’s Global Property Secs. Eq. Tracker ( ISIN: GB00B64FQP94 ) could fit the bill. This tracker fund aims to track the FTSE EPRA/NAREIT Global Real Estate Series Developed Index which is compromised of stock-market listed property companies, so this fund doesn't invest directly in bricks and mortar. Instead it holds around 300 property companies from around the developed world.

RISK INJECTION

Passive funds can also be used to ramp up the risk in your portfolio. Here are three funds we think could give your portfolio some added risk with potential to add some serious value over the long term:

Powershares FTSE RAFI All World 3000 fund (PSRW). This has a TER of 0.5 per cent and will give you a broad selection of stocks in both developed and emerging markets, focusing on stocks it calculates are inexpensive. Powershares invests in an index put together by FTSE and RAFI that focuses on companies' economics and disregards their stock market value, so it can find cheap stocks. This approach can lead to extra volatility but performs well over the long term.

If you want to invest in a commodities fund, ETF Securities Physical Gold fund (PHGP) is backed by physical gold which is held by a custodian, HSBC Bank USA. This exchange traded commodity (ETC) is a popular choice among investors and has also an Investors Chronicle award. It has a TER of 0.39 per cent.

For Emerging Markets exposure, try BlackRock Emerging Markets Eq Tracker Fund (ISIN: GB00B65W2626). It aims to track closely the performance of the FTSE All World Emerging Index by investing in companies in the Index. It invests directly into constituent companies as well as other transferable securities such as derivatives to get exposure to companies. At 0.62 per cent the TER is a snip of the cost of actively managed emerging markets funds.

 

Best trackers for you Isa (Source: Morningstar on 04/03/14)

NameISINMorningstar CategoryIMA Sector1-year cumulative return (%)3-year cumulative return (%)5-year cumulative return (%)Ongoing Charge DateOngoing Charge
Vanguard FTSE UK Equity Index AccGB00B59G4893Europe OE UK Large-Cap Blend EquityUK All Companies13.18830.91313/02/20140.150
Vanguard FTSE Dev Wld ex UK Eq Idx AccGB00B59G4Q73Europe OE Global Large-Cap Blend EquityGlobal9.46128.17713/02/20140.300
BlackRock Corporate Bond Tkr L AccGB00B5MMQ552Europe OE GBP Corporate Bond£ Corporate Bond2.72522.80403/02/20140.220
BlackRock Global Property Secs Eq Trkr LGB00B64FQP94Europe OE Property - Indirect GlobalProperty-6.30621.20903/02/20140.250
BlackRock Emerging Markets Eq Tkr A AccGB00B65W2626Europe OE Global Emerging Markets EquityGlobal Emerging Markets-15.842-12.16103/02/20140.620
SPDR S&P 500US78462F1030US ETF Large Blend13.40444.643138.074
iShares S&P 500 (Inc)IE0031442068Europe ETF US Large-Cap Blend Equity12.79042.102131.26520/01/20140.400
db x-trackers Russell 2000 1CLU0322248658Europe ETF US Small-Cap Equity19.60544.127170.47721/01/20140.450
PIMCO Sterling Short Maturity Source ETFIE00B622SG73Europe ETF GBP Diversified Bond0.52515/02/20130.350
PowerShares FTSE RAFI All-World 3000 ETFIE00B23LNQ02Europe ETF Global Flex-Cap Equity8.46817.495143.44517/02/20140.500
ETFS Physical GoldJE00B1VS3770Europe ETF Commodities - Precious Metals-24.656-9.82116.216