Ask ii: is cheaper always better for tracker funds?

A reader asks: “I like to invest in tracker funds to gain the return of an index, but I'm aware that I'm probably not in the cheapest ones available. My question is whether I should switch to the cheapest one on the market or stick with my current positions. Does cheaper always lead to better performance?”

Sam Benstead, fixed-income lead at interactive investor (pictured above), says: When picking a tracker fund, structured as either an index fund or exchange-traded fund (ETF), cost is often the first thing that an investor looks at.

This makes sense, as on the face of it a tracker fund just seeks to mirror an index, and any fee paid to the fund group will eat into returns. Over the long run, even small differences in fees can lead to big differences in performance.

There has also been a race to the bottom for tracker fund fees, with UK investors now able to pay just 0.03% a year to track the S&P 500 index (via the Super 60-rated SPXL ETF) or just 0.1% to track global shares via the L&G Global Equity Ucits ETF (LGGG).

These undercut larger funds from the indexing giants: Vanguard’s S&P 500 ETF (VUAG) costs 0.07% and BlackRock’s MSCI World tracker costs 0.2%.

Looking at ETFs tracking the MSCI World index over the past five years, there are two out in front: HSBC MSCI World Ucits ETF (77.99% return) and SPDR MSCI World Ucits ETF (77.86%) return. They charge very low fees, 0.15 and 0.12% respectively. The data is 6 June 2025.

They are ahead of the returns from iShares Core MSCI World (77.07% return) and Xtrackers MSCI World UCITS ETF (76.94%). These ETFs cost 0.2% and 0.19% respectively.

This shows that fees do make a difference, but there isn’t a perfect correlation between low fees and performance.

Fees are not the only things that matter as fund groups also have to be experts at building a portfolio that accurately tracks the benchmark index to keep the ‘tracking error’ close to zero.

Index funds and ETFs can use other tools to increase returns, such as by using derivatives to “synthetically” track an index, or stock lending, where they use their asset base to earn an extra return.

For example, iShares Core MSCI World Ucits ETF uses stock lending to increase returns on the $105 billion (£77.5 billion) it has overall in this strategy. This increases returns about 0.02% a year.

• What are the cheapest ways to track global markets?
• Overlooked way to play technology trends

BlackRock says: “Funds participating in securities lending retain 62.5% of the income, while BlackRock receives 37.5% of the income and covers all the operational costs resulting from securities lending transactions.

“With securities lending there is a risk of loss should the borrower default before the securities are returned, and due to market movements, the value of collateral held has fallen and/or the value of the securities on loan has risen.”

Synthetic ETFs can also be cheaper. Here, instead of physically owning companies, ETFs own financial contracts know as derivatives whose values are linked to the prices of shares.

The Invesco S&P 500 UCITS ETF (SPXP) charges 0.05% and employs this method. The ETF has actually beaten the returns of the S&P 500 index, according to data from FE Analytics, since launch in 2014. It is up 362% compared with 344% for the index over this period, including fees.

Some cheaper ETFs also use different index providers, which can have an impact on returns as the underlying basket of shares can be slightly different. For example, the L&G Global Equity index tracks the Solactive Core Developed Markets Large & Mid Cap index. It contains 1,409 shares versus 1,326 for iShares Core MSCI World ETF USD Acc GBP (LSE:SWDA). The Solactive index is ahead of the MSCI World index since launch in 2012, returning 367% versus 359%. The MSCI World index is used by many global index funds and ETFs.

So, overall, fees are important, but they are not everything. An investor should read an ETF factsheet to establish some more facts, such as the use of derivatives, the underlying index that’s being track, the tracking error and whether there is stock lending.