Investors have been turning to tracker funds in increasing numbers, spurred on by the stock market bounce and disappointment with the efforts of highly-paid fund managers during the downturn.

Compared with actively managed funds, trackers look simple; something even stock market novices can understand. They simply follow an index such as the FTSE all-share, aiming to replicate its performance as closely as possible.

Costs are kept low because trackers do not need to employ fund managers, make company visits or hold regular stockselection meetings. Some schemes are effectively run by computers. The cheapest do not levy an entry fee and have a total expense ratio (TER) — the best measure available of a fund’s annual costs — of only 0.15 per cent. The typical active fund charges 5 per cent upfront and has a TER of 1.6 per cent.

For investors who don’t feel that they have the time or expertise to pick and monitor fund managers, trackers offer a neat and cheap way to profit from stock market growth. But, while you might think that finding the right fund would be easy, with schemes tracking the same index performing in the same way, the reality is different. Someone who invested five years ago in both St James’s Place Tracker and Halifax UK FTSE All Share Index would expect a similar return, as both track the FTSE all-share index. But while Halifax UK FTSE All Share has generated a return of 37 per cent, St James’s Place Tracker has delivered only 22 per cent. If you had invested £10,000 in the Halifax fund, it would now be worth £13,700. The same amount in the St James’s fund would be worth £12,200.

Charges explain most of the differences in performance. Not all trackers are good value and high charges drag returns. The cheapest tracker with a 0.5 per cent initial fee and a TER of 0.15 per cent is Vanguard FTSE UK Equity Index, according to Lipper, a fund research company. It has been launched in the UK only recently so there are no performance statistics. Also good value with TERs of 0.27 per cent are Fidelity MoneyBuilder UK Index and HSBC FTSE All-Share Index. The Fidelity fund has generated 33 per cent over five years and HSBC’s fund has risen 32 per cent, ten percentage points more than St James’s Place Tracker.

The St James’s scheme is one of the most expensive funds. It has an initial charge of 3.75 per cent and a TER of 1.40 per cent, comparable to the fees charged by some actively managed funds. The most costly tracker overall is Legal & General (L&G) UK 100 Index E, according to Lipper, which comes with capital protection and has a TER of 2.04 per cent. It has delivered 21 per cent over five years.

Experts say there is no justification for high charges because the process is so automated. Chris Traulsen, the director of fund research at Morningstar, says: “There is no reason why investors should pay more than 0.3 per cent for a fund that tracks a developed market like the UK.”

Discrepancies between funds can also arise because of different tracking styles. Some managers might buy every share in an index, but many buy, say, the top 80 per cent and only a sample of the remainder. Others use a technique called stratified sampling, buying a bit of each sector.

Advisers say that before picking a fund, consider its role in your portfolio. Jason Butler, of Bloomsbury Financial Planning, says: “Ask yourself which asset classes you believe in and which indices are best. You should go for as diversified an index as you can, which means a fund tracking the all-share if you want UK exposure.”

Of the funds on offer, Mr Butler recommends Vanguard’s schemes. These do not appear on most fund supermarkets but you can buy them directly through Alliance Trust Savings (www. alliancetrust.co.uk). He also likes the Fidelity MoneyBuilder range and L&G’s trackers. L&G’s UK Index Trust has a TER of 0.51 per cent.

An alternative to a conventional index tracker is an exchange-traded fund (ETF). Like trackers, these mimic an index but tend to be more diverse, enabling you to invest in everything from hogs to gold, as well as the FTSE and stock market indices worldwide. ETFs are priced continuously on the London stock market, while unit trusts are priced only once a day.

However, ETFs can be more expensive than conventional trackers. You do not pay an initial charge and the typical annual management fee is under 0.5 per cent. There is also no stamp duty when you buy shares. But you will have to pay dealing charges to buy an ETF through a stockbroker, which can increase costs if you trade frequently. The cheapest ETFs, before dealing costs, include db x-trackers FTSE 100, run by Deutsche Bank, with a TER of 0.3 per cent and HSBC’s FTSE 100 ETF at 0.35 per cent.

Case study: We cut out the middle manager

When Charlie and Christine Barber, from Lyme Regis, in Dorset, had a substantial lump sum to invest they decided that trackers would be the ideal home for their money.

The couple invested tens of thousands of pounds in a portfolio of exchange-traded funds (ETFs) in 2007 after they sold their software business. Charlie, 59, and Christine, 61, are now retired.

“I sought advice from my accountant and we talked about risk. Together we decided that investing in trackers made the most sense.

“It enabled us to make a decision about how much to invest in stocks and shares, bonds and property without having to worry about which managers to back.”

The ETFs that the Barbers hold include iShares FTSE 100, iShares Corporate Bond and the iShares FTSE EPRA/NAREIT UK Property fund.

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