Right side of the tracks

They were so simple it seemed nothing could go wrong. But can tracking funds survive global stockmarket panic?

Among the many savers having second thoughts in the wake of the world stockmarket panic will be hundreds of thousands of people who have piled billions into "tracker funds".

Trackers invest in a basket of equities based on the FTSE 100 index or the broader All-Share index. In essence, trackers are seen as "no-brainers": invest and you will receive the benefits of any rise in the stockmarket index they are matched to. Because they don't involve fund managers in massive research, they are generally far cheaper to run than other types of fund. For the past three years, trackers have raced ahead of their more staid managed siblings.

Is this all about to change? Some people believe so. When markets commit collective suicide, tracker funds are first in line to fall - or so it is claimed. Therefore, the argument goes, investors should seek out active fund managers who can seek out ripe investment opportunities in a falling market.

It seems logical. After all, while shares may be falling, some will fall less than others. A tiny proportion will actually rise. Surely a clever fund manager can avoid dogs and select a few good 'uns? Sadly, the reality is different, at least judging by the evidence of previous stockmarket falls - in 1987, 1990 and 1994.

At the worst point in the October 1987 collapse, the All-Share index dropped 18.84 per cent, while the FTSE 100 fell 20 per cent. This, however, compared with an average 21.53 per cent drop in the UK equity and income unit trust sector, in which trackers are classed.

Similarly, in August 1990, in the aftermath of Iraq's invasion of Kuwait, the All-Share index fell by 10.74 per cent and the FTSE by 7.9 per cent. Yet the UK equity and income sector plummeted by 16.74 per cent on average. Four years later, when the All-Share fell by 6.59 per cent and the FTSE 100 fell by 7.1 per cent, the sector plunged by 12.51 per cent on average.

Yet figures compiled for The Independent by HSW, the specialist financial statistics provider, show that all bar a handful of top-performing actively managed unit trusts failed to stay ahead of the FTSE 100 and All Share indexes in the 12-month recovery that followed the worst crash, in 1987. At the time, even the best ones went down the tubes.

A similar story applies when comparing the performance of at least one tracker fund, Virgin's, which follows the All Share index. While markets dropped by up to 13 per cent from July 20 to August 24 this year, Virgin's performance, while not the best, comfortably beat the average and was certainly among the better funds in its sector.

What lesson can we conclude from this? In practice, if markets nosedive you will be no better off with most actively managed funds than one of the trackers. So, should you invest in trackers to the exclusion of actively managed funds? And is now the time to invest in a tracker fund, anyway?

Roddy Kohn, an independent financial adviser at Kohn Cougar, based in Bristol, argues: "I would not automatically dismiss trackers. They are a useful way for individuals to gain exposure to the market.

"But, ironically, the wide choice of trackers, the subtle differences between them and the varying charges they apply mean that it still makes sense to at least do your homework before investing in one.

"I also think that trackers should only form one part of a portfolio. It always makes sense to diversify, to reduce risk and maximise potential gains."

If you believe markets will fall further, you should avoid making large lump sum investments. Instead, place small but regular amounts into a fund of your choice, including trackers, and take advantage of "pound- cost averaging". This means that, as shares fall in value, you are buying more of them. In turn, when share prices rise, each one will be worth correspondingly more.

Alternatively, it may pay to diversify into other markets, notably Europe, which many experts believe still has potential for growth.

Remember investment is not for the short-term: if you invested in a tracker as if it were barely more than an instant access bank account with better returns, you have made a mistake. Think in terms of at least five years - 10 if possible. - so any "corrections" are given time to head back the right way.

Whatever you do, the starting point is not to be scared off particular investments - particularly trackers - because of unwarranted claims by some fund managers. Being panicked into a fund choice is a near-certain guarantee of serious investment pains.

One major exception should be noted. Anyone investing in a fund tracking the Japanese share index in the past decade would have been bombed to a far greater extent than most managed funds. This is because the Japanese doldrums have lasted years, not months. If the same were to happen here, all bets would be off.