HSBC Gets Smart With Index Trackers

Published in Investing on 17 September 2009

Changes to its index-tracker range make HSBC a true low-cost provider.

Here on the Fool, we've written before about the cuts in pricing that HSBC (LSE: HSBA) has made to its index tracker range -- cuts that have propelled the bank's tracker offerings very firmly into the 'Best Buy' tables.

At the time, the move was seen as a response to the arrival in the UK of low-cost American fund giant Vanguard. While that's doubtless true, now that 1 September has passed and the cut in prices has taken effect, it turns out that there's another more fundamental reason behind the move.

Statements by the bank in recent weeks have talked about positioning the tracker range so as to make it more attractive to fee-based (rather than commission-based) Independent Financial Advisors (IFAs). Comments made by a senior bank executive have also highlighted the emergence of the Financial Services Authority's Retail Distribution Review as a factor in its thinking.

(The Retail Distribution Review seeks to abolish 'hidden' commissions paid by investment funds to IFAs and fund supermarkets -- a move that's likely to see many more investors steered towards low-cost trackers and investment trusts.)

Accordingly, HSBC's tracker range now pays no commission -- a major factor in why the bank was able to cut its tracker fees so comprehensively. Its FTSE All-Share Tracker's previous annual management charge of 0.5%, for instance, was cut to 0.25%, yielding a Total Expense Ratio (TER) of just 0.27%.

Sweeping cuts

And it's here that things start to get interesting. Having taken the decision to eliminate commission, and to ready its tracker offerings for whatever emerges from the Retail Distribution Review, HSBC standardised its management charge right across the range. That's right: every HSBC index tracker carries the same cost -- although the TERs may occasionally vary from 0.27% due to the differing costs incurred in tracking foreign stock markets.

Now, here on the Fool we often talk about trackers in the context of FTSE All-Share index trackers. They're just about as broadly-diversified as it's possible to get, and are also historically lower cost.

And there's no rocket science involved in figuring out why they are lower cost: FTSE 100 trackers, for instance, have to bear the cost each quarter of re-balancing the tracker to mirror those companies entering the index and those companies leaving it. All-Share trackers, in context, just buy the market, and hold it.

But look at the flipside of HSBC's decision. Index trackers that were -- with some justification -- priced more expensively than All-Share trackers can now be bought for the same low annual management cost. The bank's FTSE 100 tracker, for instance, which had an annual management charge of 1%, now has the same low annual management as the All-Share -- 0.25%.

"It was getting confusing," explained David Chellew, head of marketing at HSBC Global Asset Management, when I spoke to him on Monday. "Trackers were supposed be a lot cheaper than actively managed funds, but weren't. Having the same annual management charge across the range allowed us to simplify our offering."

Niche opportunities

So let's take a look at what that means in practice. I know, for instance, that many investors are attracted to trackers such as those tracking America's S&P 500 index, the FTSE 250 index, and the composite Pacific index (excluding Japan). The downside: cost, compared to a low-cost All-Share tracker.

My own investment in Legal & General's well-regarded Pacific Index tracker, for instance, carries an annual management charge of 0.75%, yielding a TER of 0.82%. HSBC's Pacific Index tracker, previously priced at a comparable level, is now a fair bit cheaper. Much the same story emerges from a head-to-head comparisons of the Legal & General and HSBC American index trackers. And Legal & General, don't forget, is one of the UK's major tracker providers, with its All-Share offering being one of the very largest.

And to put the comparison at its starkest, HSBC's Pacific tracker -- with its TER of 0.37% -- compares well with newcomer Vanguard's equivalent tracker with its TER of 0.30% and an upfront charge of 0.1% -- a charge that the HSBC product doesn't levy. Equally, while Vanguard's US index product's TER of 0.20% (and no upfront charge) takes it to the top of the 'best buy' tables, the HSBC tracker's TER of 0.28% surely comes a close second.

More change ahead

In short, the size of the gap that is emerging between the cheaper players in this market and the more expensive is staggering. How is it possible for tracker providers to get away with charging 1.0% and even 1.5% annual management fees for bog-standard tracker products? Apathy, lack of understanding and interest, and sheer inertia -- none of which are likely to figure prominently with investors on the Fool.

As well as talking to HSBC's David Chellew, I've been talking to Peter Robertson, head of retail at Vanguard UK, and in an article next week I'll explore in more detail how the Retail Distribution Review will affect tracker pricing and sales on the major trading platforms.

More from Malcolm Wheatley:

As noted in previous articles, Malcolm and his delightful wife Mandy hold trackers from both HSBC and Legal & General in their SIPPs and ISAs. Malcolm also has a SIPP with Alliance Trust.

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gordonbanks42 18 Sep 2009 , 11:23pm

I've always been led to believe that index tracking is a scale business. To date, it would seem that the larger players haven't really sought to exploit their unit cost advantages to the full in the UK market.

I can see that this current round of developments might change all that. Along with enticingly lower TERs we might also see a decline in the number of providers willing to stay in the game. But then, if a tracker tracks, who needs a choice of fifteen funds tracking the same index? Perhaps, as in retail banking or the mobile phone industry, we'll be looking at a choice of 3 or 4?

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