Should you buy into the new breed of tracker funds?

Tracker funds are often seen as one of the best options for private investors looking to invest in the stockmarket.

They are cheap, they're easy to understand, and in most cases they outperform their more expensive, managed counterparts. However, that doesn't mean they're without their problems. The trouble with traditional trackers, critics argue, is that they buy stocks when they are expensive in other words, as they are rising up the stockmarket leaderboad and sell them when they are cheap. For example, in early 2000, tech stocks made up a big proportion of the S&P 500, just as the tech bubble was about to burst, which a traditional tracker would have blindly followed despite the fact that, on fundamental measures, the stocks were hugely overpriced. As Ed Bowsher puts it on Motley Fool, "history suggests that investors frequently pay too much for growth shares and don't pay sufficient attention to the money-making potential of high-yield shares".

But now a new breed of tracker is heading for the UK, aiming to resolve this problem. Unlike traditional trackers, "fundamental" or "intelligent" tracker funds aim to take account of the more basic merits of firms, including turnover, profits and dividend yield. "These kind of funds are effectively value' trackers," says Bowsher, "and I think they could be strong long-term performers." Research bears this out. Had you invested $1,000 in 1962, it would have grown to $74,000 in the S&P 500, or to $156,000 in a fundamental tracker, observes Alistair Blair in Investors Chronicle. But as always, it's not that simple. While value investing is generally thought to pay off long-term, "you could miss out when markets are buoyant", says Bowsher.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

If everyone is piling into "expensive shares in a sexy sector", a normal tracker will follow suit, but "a fundamentals tracker may well be underweight in the fast-rising shares". As can be seen from the chart, the FTSE 250 index has indeed outperformed the iShares FTSE UK Dividend Plus fund (which invests in the highest-yielding 50 stocks in the FTSE 350) in recent times. But this may just be further evidence that mergers and acquisitions fever and the hunt for yield are pushing investors to chase stocks higher for the wrong reasons, rather than focusing on traditional measures of value.

If you are interested in fundamental trackers, the aforementioned iShares fund, which has annual fees of 0.4%, is one of the best options for UK investors, says Andy Gadd, head of research at independent financial adviser Lighthouse Group, in the FT. But for a wider choice, you have to go abroad. There are nine fundamental exchange-traded funds listed on the Nasdaq, specialising in sectors from energy to healthcare, says Matthew Richards in the FT, while this week, Paris-based Lyxor launched ETFs that act as fundamental trackers for Europe, the US and Japan.