I’m going to talk about what tracker funds are, also known as index funds, or ETFs. While there is more that could be written into my explanation, I’m just going to take my usual poetic licence using a simple example.
A tracker fund is a unit trust investment in which the shares held always have to match the average value of a specified basket, or a specific part or group of a stock market. Companies are bought when they meet the specific rules of the group, likewise they are sold if and when they move outside of those parameters. The fund follows an average, a predefined grouping. No subjective input is required from the fund manager. I am going to paint a picture by using our beloved Springbok Rugby Team.
Let’s assume the team is selected on weight. Our coach Rassie has no subjective choice: the heaviest player by position in the country gets that position. Let’s further assume that our dancing man, Trevor Nyakane, is our tighthead prop because he is the heaviest number 3 in the land. He then decides that he needs to become more mobile around the park, so he stops eating those 7 cheeseburgers a week and joins the local Park Run. He sheds 10kg and becomes a faster man. But now he is no longer the heaviest #3 in the land – he now weighs less than Frans Malherbe. So Trevor goes out the team and Frans comes in. A simple objective process. No opinion allowed.
Likewise, our lightning wings in the form of Cheslin Kolbe and Kurt-Lee Arendse would not be in the team. They just don’t weigh enough.
Rassie gets given this team without choice and has to work with that. The team selection follows a pre-defined set of rules. SA Rugby can pay him a lower salary because he has less thinking to do.
There might be many occasions when this ‘heaviest team’ wins, or does well. But there are crucial occasions when they might not, times when the subjective coaching interference might create better results. Likewise with tracker funds. They represent an average investment and might often do better. Likewise they carry lower fees, because the fund manager simply follows rules and doesn’t have to do any real decision making.
There will be times when the shares of a couple of companies have to be held, that might actually not be good to continue holding, but they have to be held until they fall outside of the rules. I’ll use the share of British American Tobacco for an example. One fund manager I use told me earlier this year that they had sold what they held of this company quite a while ago. I asked him why. He said they do not expect it to be able to continue growing its dividend in the years to come, so they have taken profits and sold. BAT’s share price has indeed declined a fair amount over the past year. An active fund manager can choose to sell. The tracker fund cannot sell until BAT’s weighting falls outside the parameters and in some cases, carrying that permanent loss into the fund.
Many coaches might not be good enough to create anything more than an average team, that it the catch.