Unit Trusts & Open Ended Investment Companies

Unit trusts and Open Ended Investment Companies (OEICs) are by far the most popular investment funds. With a unit trust, a fund manager buys bonds or shares in companies on the stock market on behalf of the fund. The fund is split into units, and this is what you'll buy. The fund manager creates units for new investors and cancels units for those selling out of the fund. The creation of units can be unlimited, hence why the fund is 'open-ended.'

The price of each unit depends on the net asset value (NAV) of the fund's underlying investments and is priced once per day. This means that the value of the units you buy directly reflects the underlying value of the investment.

OEICs operate in a similar way to unit trusts except that the fund is actually run as a company. It therefore creates and cancels shares rather than units when investors come in and go out of the fund, but they still directly reflect the value of the assets that your fund manager has invested in.

How do unit trusts and OEICs pay returns?

Returns from the fund are paid through distributions. These can be monthly, quarterly or every six months, depending on the type of fund that you invest in. These distributions derive from the dividend payments received by the fund from the underlying shares within which they invest, or interest payments from bonds or even rental income in the case of property.

Most unit trusts and OEICs will give you two options to choose from for payment - income or accumulation. Income units pay the distributions as income, while accumulation units wrap up those distributions and reinvest them in the fund, to increase the capital value of your investment.

You'll be taxed differently according to whether or not you invest in income or accumulation units.

Where can unit trusts and OEICs invest?

There are over 2,000 different unit trusts and OEICs available to investors in the UK, investing in over 30 sectors. These sectors have been categorised by the investment management association (IMA) and are split between the asset class (like funds investing equities, fixed interest, and property), geography (such as UK Equity, North America, Japan and Emerging Markets), sector type (like Technology and Telecoms) and investment style (such as Growth or Income).

Unit trusts and OEICs have evolved a lot over the years and no longer invest simply in one asset, sector or region. For example, the IMA lists three sectors of managed funds - Mixed investment 0-35% shares, Mixed investment 20-60% shares and Mixed investment 40-85% shares - which invest in multiple assets to provide investors with a diversified portfolio housed within one fund.

There are funds that invest in other funds, called multi-manager or fund of funds. Rather than investing directly into individual assets, these funds invest in other collective investments, with the expectation that specialist managers in the various asset classes will produce top performance.

How much do these types of funds cost?

You'll encounter two costs when investing in unit trusts and OEICs. The first is an initial fee, usually around 5%, levied as a set up fee for buying units or shares. With unit trusts, the initial fee is usually the difference (the spread) between the offer price (the higher, buying price of the units) and the bid price (the lower, selling price) on the day of purchase. OEICs have just one price, and therefore the initial fee is simply a percentage of your overall investment.

In addition to this, you'll pay an annual management charge (AMC). Actively managed funds typically charge around 1.5% as an annual charge but when you take into consideration things like admin, legal and custodian fees, the total annual cost of a fund can often be much higher than the AMC. This is often published as the total expense ratio (or TER) and is a far more realistic reflection of the annual costs that you pay. Tracker funds, which are essentially run by computer, are far cheaper.

It may only seem like a small amount, but costs have been found to be the biggest drag on performance in investment funds. The argument for the higher costs is that you're paying a premium for the expertise and better performance that a professional fund manager can offer.



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