Fund researcher and ratings group RSMR has responded to the issue of costs and tracking errors in passive funds by creating a 'guide to passive investing' as part of its new service on passive funds launched recently.

Chris Riley, investment research manager at RSMR, said: "Passive management is becoming a more popular choice for advisers when creating portfolios for their clients and many now consider a mix of tracker funds or passives, which can complement actively managed funds or investment trusts in certain areas.
''All too often it seems that investors focus on one or two factors when assessing passive fund managers, at the exclusion of the bigger picture. Perhaps the two most common factors would be fees and tracking error. But the assessment of passive fund managers is not as simple as that - a more comprehensive set of factors should be taken into account."
He believes that while fees are important, the lowest fee manager may not track the index as efficiently as others in the market. A similar argument can be made for tracking error, as statistics can give a highly misleading picture if the manager prices their fund at a different time of the day to the benchmark, he says.

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He added: ''Our research highlights the need for stringent and detailed due diligence in the passive fund world – our decision to rate a tracker fund is not based solely on tracking error and annual costs. Advisers will realise that manager scrutiny and rigorous analysis are not reserved for the realm of active funds - they can, and should, be applied more broadly within the investment universe.
RSMR believes that there is a lack of quality research explaining how to use passive funds effectively and how to ensure appropriate due diligence is in place to support recommendations and meet FCA requirements.