This week major tracker fund player Vanguard threw down the gauntlet to its competitors by lowering the ongoing charges on 25 of its index tracker funds and exchange-traded funds (ETFs) by up to 15 basis points. The 25 funds now cost between 0.07 and 0.38 per cent, compared with 0.09 and 0.40 per cent previously.
Vanguard's announcement came the day after Fidelity claimed to have the cheapest tracker funds and has brought its range more in line with Fidelity's charges. The news follows the announcement from the Investment Management Association that July 2014 was the top month ever for tracker fund sales.
However, investors need to choose tracker funds carefully. The ongoing charges are important. But you also need to check the upfront costs of investing in a fund, such as Vanguard's dilution levy. Vanguard takes a dilution levy on some of its funds to cover the costs of investing in a fund. Vanguard does not profit from this levy – it is used to protect long term investors from trading costs of new investors.
Since Vanguard funds must be purchased via a platform, unless you can stump up the required £100,000 minimum per fund to buy direct, choice of platform will have a significant impact on how much you end up paying in total.
According to Candid Financial Advice, in the case of the Vanguard FTSE UK Equity Index fund, annual platform costs could end up being five times more expensive than the fund itself. The company says that for a £10,000 Isa investment in the Vanguard FTSE UK Equity Index Fund costing 0.08 per cent a year, total annual costs via popular platforms will be as follows.
iWeb £8 (no annual platform fee)
Charles Stanley Direct £33 (includes 0.40 per cent platform fee)
Hargreaves Lansdown £53 (includes 0.45 per cent platform fee)
Chelsea Financial £68 (includes a 0.60 per cent platform fee)
The war on fees among tracker funds, plus the rapid dropping of fees among exchange traded fund providers, should also serve as a wake-up call to the UK's active fund managers, who mostly show little inclination to cut their fees. The worst offenders are those running larger funds that undoubtedly benefit from huge economies of scale, yet refuse to cut their fees accordingly.
Justin Modray, the director of Candid Financial Advice, singles out the £20.8bn Standard Life GARS fund where he estimates the 0.75 per cent annual management charge generates revenues of around £156m, and the £12.9bn Invesco Perpetual High Income fund which he says "probably makes the firm towards £100m a year". "In such instances there is ample fat on the bone to cut charges and give customers a better deal," he says.
In the United States, it is common practice for active fund managers to pass on economies of scale to investors. Typically, US management fees contain breakpoints that reduce fees above set levels.
Three important things to check out before investing in a tracker fund
1. How the fund is replicated – does it buy every stock in the benchmark index or does it use a sample of stocks?
2. Does the fund have a stock-lending programme? This means the fund manager has an additional source of revenue and should be able to pass it on to investors in the form of reduced costs. However, it will increase the risk of investing in the fund.
3. Has the fund performed in line with its benchmark index? Funds should be able to show investors how they have performed in relation to the index over various time periods.
