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Ways to build a low-cost portfolio

 
Rob Morgan
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Low-cost ‘passive’ funds can offer a simple and transparent way to invest. (Source: Shutterstock)

In contrast to ‘active’ funds that employ fund managers to try and select the best performing investments, passive investments or “trackers” simply aim to replicate the performance of an index, say, the FTSE 100, usually by holding all or most of the constituents.

Some people are advocates of active investing – trying to beat the market. Yet for others who prioritise cost, or simply don’t believe active managers can consistently outperform in a particular investment area, passive investing represents a potentially appealing route.

Our view is that there are pros and cons for both methods. Charges are generally lower for passive funds, especially for the competitive offerings from the likes of Vanguard, Fidelity and Legal & General. They are also simple and transparent – you should get a similar return to the relevant market. Over the long term, though, a passive approach will end up marginally underperforming its benchmark due to charges, however small they are. In contrast, active management can lead to a wider range of possible returns, good and bad!

A competitive market

The market for tracker funds following major indices is highly competitive. For exposure to various international equity markets such as the US, Asia or Japan, Fidelity’s Index range offers low charges while BlackRock, Vanguard, HSBC and Legal & General also have funds worth considering, with the latter having some more specific fixed interest options such as global inflation-linked bonds and or short dated corporate bonds. Legal & General also has some more specific equity index options such as global health and pharmaceuticals and global technology.

Passive funds on the Foundation Fundlist

The Foundation Fundlist is Charles Stanley Direct's list of preferred investments across the major sectors. For those that are interested in constructing a low-cost passive portfolio the list has some options providing access to the major investment areas. We believe they are options worth highlighting for their transparency and value for money:

Corporate Bonds

BlackRock iShares Corporate Bond Index (OCF* 0.16 per cent)

Legal & General Short Dated Sterling Corp Bond Index (OCF 0.14 per cent)

UK Equities

Fidelity Index UK P (OCF 0.06 per cent)

Global equities

Fidelity Index World P (OCF 0.12 per cent)

International equity markets

Legal & General European Index (OCF 0.12 per cent)

Legal & General Japan Index Trust (OCF 0.15 per cent)

Legal & General Pacific Index (OCF 0.19 per cent)

Legal & General US Index (OCF 0.10 per cent)

Vanguard Emerging Markets Stock Index (OCF 0.27 per cent)

Please note inclusion here does not imply a specific buy recommendation and past performance is not necessarily a guide to the future. The value of investments, and the income derived from them, may fall as well as rise and the amount realised may be less than the original sum invested. Charles Stanley Direct's usual charges apply to holding tracker funds on top of the fund’s own charge.

*OCF - The ongoing charges figure included the cost of investment management and administration, plus other costs of running the fund, such as fees for custodians (organisations that hold the assets safely for the investment managers), regulators and auditors. It will not include trading costs nor any performance fees. However, these fees will be published separately on the Key Investor Information Document or Key Information Document. These figures can change and are correct at the date of this article.

Even more options: Exchange Traded Funds (ETFs)

There are a plethora of further passive options ranging from conventional equity indices to esoteric ones such as individual countries or sectors. ETFs are traded on the London Stock Exchange, which means unlike funds that are priced once a day, pricing is normally continuous during market hours. For this reason they may appeal to shorter-term traders as well as investors looking to track a given index for the long term. Major providers of ETFs include db X-trackers, ETF Securities, iShares and Vanguard.

ETFs are designed to be low cost products, though it should be borne in mind that as well as the annual charge there are the usual costs associated with dealing in shares – stockbroking commission, stamp duty and the ‘spread’ between buying and selling prices.

The risks of ETFs vary significantly. Not only do they invest in all sorts of different areas, some of which can be exceptionally volatile, but they have a variety of different structures which makes it very important to understand what you are buying. In particular, those based on derivatives rather than physical holdings have additional risks attached.

Existing passive funds

If you have longstanding tracker funds in your portfolio it is worth checking the charges. Some older passive funds have relatively high annual costs, sometimes in excess of 1 per cent. Investors in these funds may want to consider alternative funds or ETFs as the relatively high charges will be a drag on performance and over the long term could possibly result in poorer returns.

Investors should be aware that past performance is not a reliable indicator of future results and that the price of shares and other investments, and the income derived from them, may fall as well as rise and the amount realised may be less than the original sum invested. No news or research item is a personal recommendation to deal. Investment decisions in collectives should only be made after reading the Key Investor Information Document or Key Investor Document, Supplementary Information Document and/or Prospectus. If you are unsure of the suitability of your investment please seek professional advice.

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