Tracker & ETFs: Pros and cons

The advantage of a tracker is that it is very low cost and you don’t need to monitor investment managers. It is also easy to have a very diversified portfolio that will tend to be less volatile than a more concentrated portfolio.

Trackers can be thought of as the default option for investors that don’t want to seek out active fund managers. Investors can get a global portfolio and are therefore less exposed to home country risk.

A disadvantage of trackers is that you will get only the market return minus any fees. However, you can pick a tracker that you think will deliver the strongest long-term returns i.e. US equities might be one example.

Exchange Traded Funds (ETFs) are listed funds and they can therefore be bought on different platforms. However, there is such a selection of ETFs out there with some tied to very specific themes i.e. nuclear power.


Investment Trust: Pros and cons

Investment Trusts are listed on stock markets in the same way that general companies are listed. They have a fixed amount of capital and the board of directors is responsible for ensuring the managers deliver good results.

The advantage of Investment Trusts is that they can plan for the long-term given the fixed investment capital. They can also use leverage and can invest in areas that open-ended funds would find problematic i.e. unlisted companies.

There is some evidence that Investment Trusts outperform an open-ended fund when they are run by the same manager. Investment Trusts don’t have cash on hand due to the inflows and outflows of funds.

A disadvantage of Investment Trusts is that they can be difficult to buy and sell and the shares tend to be volatile. It can also be difficult, in practice, to change the direction of an Investment Trust even if the performance has been poor.


Open-ended funds: Pros and cons

Open-ended funds have received a significant amount of criticism with studies showing that on aggregate they underperform. This reflects the zero-sum gain nature of investing: for some people to outperform others must underperform.

Open-ended funds also don’t appear to be appropriate for volatile asset classes such as emerging markets and micro-cap companies. Against this backdrop the obvious question is: what is the case for investing in open-ended funds?

Key advantages include the huge amount of choice and the ability to buy and sell at the value of the assets. Investment trusts trade around their asset value due to supply and demand but open-end funds redeem at their asset value.

New active managers may not be able to launch and Investment Trust and will therefore start with an open-ended fund. There have been a number of very compelling success stories in the open-ended fund space.

A key issue for investors in an open-ended fund is that it is likely to attract a significant inflow of capital if the performance has been strong. This will is likely to make it difficult to perform as well going forward.