MONEY MAIL: Time to track the best system

By CHARLOTTE BEUGGE FOR MAILONLINE
Updated: 16:40 EST, 16 October 2009

Despite their large salaries, few fund managers beat stock market indices.

According to figures from adviser Bestinvest, of the 1,442 investment funds with track records of at least five years, only 27 outperformed their relevant index in each of the past five years.

Added to that, charges on actively managed funds mean you lose a large chunk of your money each year, even if the fund manager fails to do any better than a computer-generated fund which simply follows the index.

Number crunching: Fund managers aim to beat the markets

However, with the current topsy-turvy stock market, the pricing system used by investment funds makes it difficult for investors to maximise their profits.

Unit trusts and Open Ended Investment Companies (Oeics) all use a system called forward pricing.

This means that if you trade on Monday afternoon, you won't get the price current at that time.

Instead, you'll actually get the price at midday on Tuesday. That's no good to anyone want-to take a quick profit on stock market moves. But there is a way of investing cheaply in an index tracker and being able to get real-time prices.

Exchange traded funds (ETFs) follow a range of indices but because they are shares, when you sell or buy them you know exactly what price you are paying.

ETFs track anything from the FTSE All Share index to the cost of pork bellies, wheat or gold. You will have to pay stockbroking-commission, but there's no stamp duty. Typically they have charges of about 0.5 per cent rising to about 1per cent for the more esoteric indices.

Few advisers will tell you about them because they don't pay commission.

Europe-wide, more than £133billion of ETFs were sold over the year to the end of August.

While the ETF market in the UK has doubled over the past year, few UK investors have ETFs. In the US, the typical investor has 8pc of his portfolio in ETFs compared with a negligible number here.

While usually ETFs are covered by the Financial Services Compensation Scheme, there is a potential complicated risk with ETFs, particularly those tracking commodities.

All but a few commodity ETFs rely on derivatives to track their chosen index so this means there is counter-party risk.

Ben Yearsley of adviser Hargreaves Lansdown explains: 'This potential problem emerged last year when AIG almost went bust.

'It provided many of the derivatives for ETFs and as a result, the pricing of some ETFs went haywire.

'The situation did right itself eventually, but it did highlight a potential downside of ETFs.'

One market where ETFs really do make more sense than an actively-managed fund is the US.

Darius McDermott of advisers Chelsea Financial Services says: 'The American market is so overdeveloped that active fund managers can't add value, so a tracker makes sense.

'And the cheapest way to do that is through an ETF tracking the S&P 500.'