What is a tracker and how do you choose the right one?

What is a tracker? What is an ETF?

A tracker (also referred to as an index fund) on the stock exchange is a fund that invests money in companies included in a specific index on your behalf. It automatically tracks the performance of the stock market index, which is a basket of shares, bonds, currencies and commodities. In other words, if the index in question rises by 1%, the tracker will also increase by 1%.

A tracker combines certain properties of shares with those of traditional investment funds. Like shares, trackers are listed on a stock exchange, so you can buy and sell them in real time. Just like an investment fund (which is not listed on a stock exchange), you can use a tracker to instantly diversify your investments. For example, if you buy a STOXX Europe 600 tracker, you indirectly invest in all 600 constituents of that index without having to buy shares in 600 individual companies separately.

What trackers are out there and what are the differences between them?

When we talk about trackers, we usually mean exchange-traded funds or ETFs. However, there are other types of trackers as well. Although this is quite a technical subject matter, it is useful to know the differences between tracker types so you can always make an informed decision. Let's take a look at an overview of the various tracker types.

• Exchange-traded funds or ETF tracker

When you invest in an ETF, you invest in a product that owns the assets it is tracking. These assets may consist of shares, bonds, precious metals, commodities or futures. The ETF may also not own the assets but replicate them by buying derivatives (such as swaps and options). The first method (physical replication) is much more transparent than the second method (synthetic replication).

• Exchange-traded note or ETN tracker

An exchange-traded note is more like a bond: it is a debt instrument issued by a financial institution. Like a bond, you can hold an ETN until maturity or sell it sooner. When you buy an ETN tracker, the issuer promises the return will be linked to the underlying instrument. This means you are guaranteed to keep your deposited amount.

An ETN can be linked to almost anything. There are ETNs that track commodities, but they are often linked to products and areas of the stock market that are difficult to access for private individuals. ETNs sometimes combine share and bond positions or use strategies that are difficult to package in a traditional ETF.

• Exchange-traded commodity or ETC tracker

An exchange-traded commodity is a tracker that offers investors access to commodities such as metals, cotton, livestock, natural gas and even CO2 rights. An ETC tracker can track individual commodities or a mixed basket of commodities. This tracker is a potential alternative for those who wish to invest in commodities on the futures market.

• Exchange-traded product or ETP

An exchange-traded product or ETP is not a tracker in itself, but rather a collective name for all types of trackers that exist. ETFs, ETNs and ETCs are therefore all ETPs.

Which tracker should you choose? A step-by-step plan

• What exactly do you want to track?

The days when all you could invest in were traditional share indices are long gone. Today, there are products that track all kinds of assets, regions, sectors and themes.

The first step is to find out exactly what you want to invest in. Do not rely blindly on the name of the tracker. Instead, look at what actually happens behind the scenes. This information can be found in the Key Investor Information Document (KID). This includes information on whether the tracker actually buys the underlying assets or imitates them with derivatives.

It is also best to verify the composition of the underlying positions, which can usually be found on the provider's website. Two trackers that follow 'global banks', for example, may both be invested in very different holdings and/or with different weightings. One tracker might track a basket of traditional high-street banks, while the other also tracks fintechs, insurance companies and asset managers.

These days, (almost) anything is possible. However, before you shop around, it is a good idea to set out a strategy for your investments.

• Reinvestment or distribution?

Like investment funds, trackers sometimes have a distribution and reinvestment variant. Any dividends and/or coupons that are paid out are reinvested if you choose reinvestment. Dividends and/or coupons are paid out if you choose distribution.

To find out more about the differences between reinvestment and distribution, read this blog.

3. What is the cost price?

Unlike actively managed investment funds, a tracker does not have a full investment and analyst team behind the scenes (though sometimes there will be a manager). As a rule, a tracker is a passive investment vehicle: it seeks to imitate an index – nothing more, nothing less. This is why trackers are generally significantly cheaper than fully actively managed investment funds.

This doesn't mean that all the providers (Amundi, Barclays, iShares, DB-X trackers, Invesco, etc.) have exactly the same operating costs. And those costs can have an impact on your return over the long run. You can easily compare the costs between the different providers on websites such as etf.com and Morningstar.be.

4. Take into account the tracking error

The tracking error is the difference between the performance of the tracker and of the index itself. Although trackers are (generally) passively managed, this doesn't mean they are run solely by algorithms. Sometimes there is still a manager in the background who can reduce the tracking error, for example by lending shares to investors who want to short a share, and collect a fee.

This means that if you pay 0.5% in running costs and the ETF has a tracking error of 0.4%, you are 0.9% down. The smaller the tracking error, the better. To find out the extent of the tracking error, you can consult the Key Investor Information Document (KIID). You can also compare the tracking errors of different ETFs on the aforementioned websites.

5. Trading volume and liquidity

The trading volume is an excellent indicator of liquidity. Generally, the higher a tracker's trading volume, the more liquid it tends to be and the smaller the gap is between the ask and offer prices. If you have a choice between trackers with similar characteristics, the one with the most liquidity is usually the preferred option.

Getting started with trackers

Although trackers themselves are passive investment vehicles, selecting and managing them is something you need to do actively. At Keytrade Bank, you can choose from around [600] trackers. If you prefer to leave the selection and management to a team of professionals, KEYPRIVATE allows you to invest in a personalised portfolio of trackers that is actively managed by our experts.