Index Tracker (also known as an 'Index Fund')

An index tracker is a type of mutual fund or, more commonly, an exchange-traded fund (ETF) designed to be the ultimate copycat. Its sole purpose is to replicate the performance of a specific financial market index, like the famous S&P 500 in the US or the FTSE 100 in the UK. Instead of employing a team of highly-paid analysts to pick winning stocks, the fund simply buys all (or a representative sample of) the stocks or bonds in the index it follows. This hands-off approach is known as passive investing. The beauty of this strategy lies in its simplicity and, most importantly, its incredibly low cost. Because there's no active management or complex research involved, the fees associated with index trackers are typically a fraction of those charged by actively managed funds. This makes them a powerful and popular tool for investors looking for broad market exposure without the hefty price tag.

Think of an index tracker as a pre-packaged investment basket. If you buy a tracker fund for the S&P 500, your money is used to purchase shares in all 500 of America's largest companies, from Apple to ExxonMobil, in the exact same proportions as they are weighted in the index itself. If a company is kicked out of the index, the fund sells it. If a new one is added, the fund buys it. The fund manager's job isn't to be a genius stock-picker, but rather a diligent administrator, ensuring the fund's holdings mirror the index as closely as possible. This process is what keeps the fund's expense ratio—the annual cost of running the fund—rock-bottom. The goal isn't to beat the market; it's to be the market. By owning an index tracker, you are guaranteed to get the market's return, minus a tiny fee. Given that most active fund managers fail to consistently beat the market over the long term, this is a very compelling proposition.

For a follower of value investing, index trackers present a fascinating dilemma. They embody some core virtues while violating others.

• Disciplined Low Costs: This is the biggest plus. Value investors despise unnecessary costs that eat into returns. The razor-thin fees of index trackers align perfectly with this frugal mindset. Legendary investor Warren Buffett has repeatedly highlighted low costs as a key to investment success for the average person.
• Effortless Diversification: With a single purchase, you can own a slice of an entire market, dramatically reducing the unsystematic risk associated with holding just a few individual stocks.
• Eliminates Emotional Error: A tracker fund is unemotional. It buys and sells based on the index's rules, not on fear or greed. This enforced discipline can protect investors from their worst behavioural impulses.

• Indiscriminate Buying: This is the core conflict with value investing. A tracker buys everything in the index—the overvalued darlings, the fairly-priced workhorses, and the struggling laggards. A value investor, by contrast, is highly selective, hunting for wonderful businesses trading at a discount. A tracker forces you to buy the market's priciest stocks alongside its worst.
• The Market-Capitalization Weighted Trap: Most major indices are weighted by market capitalization, meaning the biggest companies make up the largest portion of the index. This forces you to invest more money into the stocks that have already seen the biggest price run-ups, which is the opposite of the value investor's creed to “buy low.”
• Zero Margin of Safety: The cornerstone of value investing is buying an asset for significantly less than its calculated intrinsic value. This buffer protects you if things go wrong. An index tracker, by definition, buys at the current market price, offering no margin of safety whatsoever.

So, what's the verdict? Index trackers are a fantastic financial innovation and, for the vast majority of people, they represent the single best way to invest in the stock market. They are simple, transparent, and incredibly cheap. As Warren Buffett advises, a low-cost S&P 500 index fund is a far better choice for most investors than trying to pick individual stocks or paying high fees to an active manager who is likely to underperform. However, for the dedicated value investor—the individual committed to the craft of business analysis and valuation—an index tracker is a starting point, not a final destination. It represents buying the entire haystack. The value investor's quest is to patiently search that haystack for the few, deeply undervalued “needles” that the market has overlooked. Using an index fund as the core of a portfolio is a perfectly sensible strategy, but the true pursuit of value requires the courage and discipline to deviate from the crowd and buy great companies at great prices, one at a time.