For most private investors the obvious answer is to purchase units in an Index Tracker Fund then sit back and enjoy market average growth. There are 12 tracker funds available in South Africa, five of which invest in the market giant companies of the ALSI 40 and two that are set up to track the All Share Index. So any one of them should do, right? Well not really.

You see, not all tracker funds are as good as their peers when it comes to following the index that they are supposed to track. Then, to make matters worse, most of them have a similar buy to sell cost (also referred to as spread) to that you would expect to pay for the services of an actively managed fund, while doing a lot less work for this money. Therefore, it may be important for you to establish which funds have the best record for staying close to their chosen index and it is vital for you to compare the cost of doing business with these funds.

The most glaring example of an initial cost disadvantage is the 6.04% spread for Standard Bank Index Fund that contrasts sharply with the 0.60% spread for Investec Index Fund. Both of these fund invest across the JSE All Share Index and return growth that is usually within around 1% of each other. Profile Media figures an (AUT authorised statistics provider) for periods ending on 31st December 2001 showed a three-year growth of 28.67% p.a. for Investec Index while Standard Bank Index yielded 27.54% p.a.

The plot thickens when you see that Standard Bank Index has no annual management charge while Investec Index takes 0.40%. The effect of these different pricing structures should generally mean that Investec Index will yield a higher return than Standard Bank Index unless you stay with either selection for many years. For example, if you invested R10 000 with each fund and enjoyed 15% growth per year, it would take over 14 years for Standard Bank Index to breakeven with Investec Index. Thereafter, the former fund would yield a slightly higher net return. So chose Investec Index if you will be holding the units for less than 14 years and Standard Bank Index if you’ll be holding for longer.

This effect is often carefully ignored by Fund Managers who prefer to suggest that you should choose the fund that most closely tracks the index over any given period. Management teams, however, have certain practical problems in achieving this, such as the requirement that unit trusts hold 5% in cash at all times which means they can't fully replicate the index.

Willem van der Merwe, from Coronation Asset Management, says that ‘the most important reason for tracking error is poor management of client cash flows. Tracking errors often arise when there is a mismatch between pricing and when re-balancing of the portfolio takes place. The second biggest factor is the 5% cash requirement. If you analyse the portfolios of tracker funds, they often have slightly more than 5% in cash because they are not accurate enough in measuring cash flows’.

Figures provided by Profile Media for the year ended 31 December show that, in the competition to stay close the ALSI 40, Coronation Alsi 40 Tracker Fund got closest to the target (29.2% growth, on the Sell to Sell figures, for the year compared to an index return with dividends of about 29.5%), while Liberty Alsi 40 was furthest from the mark at 25.76%. Considering then that Coronation Alsi 40 offers an extremely small 0.47% spread and its next most cost effective challenger is Old Mutual Alsi 40 at 6.21% it is fairly obvious which ALSI Tracker Fund you should run with.

It’s interesting to note that index values are generally quoted without the effect of dividends and Nic Oldert, Managing Director of Profile Media, says that Alsi 40 tracker funds should have outperformed the index by about 0.8% in the year to 31 December, 2001 because of dividend income.

Yet when we take dividends into account it still seems that some funds have out-performed the index. In fact, over the past one, two and three years, Coronation Alsi 40 has yielded growth that is, on average, 1.38% above its index while Sanlam Index Trust is averaging just 0.1% above the index which is an under-performance when you take dividends into account.

Since mid 1996, ALSI 40 shares have had an average dividend yield between 1.9% and 3.4%. Therefore, it would seem logical for an efficient fund to out-perform the (ex-dividend) ALSI 40 index.

From an investors point of view the conclusion seems clear. When you are investing in a local Index Tracker Fund choose one that has a lower Buy to Sell spread combined with results that are consistently above the index results. Over the long run (after initial investing charges are overcome) it should be possible for an ALSI 40 Tracker Fund to beat the (ex dividend) index numbers by almost 1% due to the annual dividend income.

Although 1% per year may not sound like much over one year it makes an enormous difference over 20 years. Ten thousand rand invested at a net growth of 21% per year would become R452 593 in 20 years. The same R10 000, invested at a net growth of 22% per year would return R533 576. The R80 983 difference is not 1% more, it’s 17.9% more.

So it is very important to look for those funds that have low Buy to Sell spreads and a consistently positive tracking error then you will see that some tracker funds are truly more equal than the others.