Unit Trusts And OEICs

Most people choose to invest in an investment fund rather than buying shares directly on the stock market. There are many different types of fund. Some, like investment trusts and exchange traded funds, are traded on the stock market and can be bought and sold via a stock broker. (More about those later.) Others, such as unit trusts, insurance and pension funds, can be either bought directly from the company that runs them or via a discount broker, fund supermarket, or Independent Financial Adviser.

To start with we’re going to look at unit trusts and open ended investment companies (OEICs). These two types of fund operate in a very similar fashion, which is why they are often grouped together. Over the last few years many companies have been converting their unit trusts into OEICs, mainly for technical and administrative reasons. Note that OEICs are sometimes also called ICVCs, which stands for investment companies with variable capital. The financial services industry loves its jargon!

There a few thousand unit trusts and OEICs in existence at the moment, and these funds are provided by around 100 different companies, some of the largest managers being Fidelity, Invesco Perpetual, Legal & General, and Schroders.

These funds are usually divided into geographical sectors, such as UK, Global, US, European, Far East and so on. Further sub-divisions are often made into Growth, Income or Smaller Companies funds, or funds that specialise in particular sectors, such as Mining or Biotech. These categories are only rough guides, however, and it is often possible for two very different types of fund to be grouped together in the same sub-category.

How these funds work

Unit trusts and OEICs are both known as “open-ended”, because their size is not limited. Imagine that you have £10,000 invested in a unit trust with a total of £10 million of assets. If you decided to withdraw your investment, then the fund’s total assets would go down to £9,990,000. However, if you decided instead to add another £10,000 to your investment, then the total assets would go up to £10,010,000.

The effect of this is that if a fund suffers a large number of “redemptions” (that is, withdrawals), then it will have to sell some of its investments in order to provide the money for the investors that are pulling out. Similarly, when lots of people are adding money to a unit trust, that trust has to buy more investments in order to maintain its investment profile.

Although it is hard to say how significant this effect is, it generally has a net negative effect for investors, as it means shares are bought and sold on a frequent basis and this incurs transaction costs.

As a general guide the minimum amount you can invest in a unit trust or OEIC is £500 in a lump sum or £50 per month, but it varies from fund to fund. Many funds have ‘income’ and ‘accumulation’ units. Income units pay you a dividend, usually twice a year. Accumulation units automatically re-invest your dividends back into the same fund. Note that, whichever type of unit you choose, the dividend is treated the same for tax purposes.

Charges

With unit trusts and OEICs you have to watch out for both initial charges and annual charges. And just to add to the confusion, both of these charges will vary depending on who you actually buy the fund from.

Initial charges are typically 5%, often because part of this is used to pay an adviser commission when you put your money into a fund. However, you can often get a much lower initial charge (sometimes as low as zero) by going via a discount broker or fund supermarket. Somewhat perversely, buying a unit trust or OEIC directly from the company that provides it is often the most expensive option.

Annual costs are typically in the region of 1.0-1.5%. Index-tracking funds and funds that invest in corporate bonds are usually slightly cheaper. As with all funds look at the Ongoing Charge Figure (OCF) rather than just the annual management charge if you want the fairest comparison of the cost of two or more funds. The OCF should include additional costs, like audit and trustee fees, which aren’t included in the annual management charge. You can usually find this information in the Key Investor Information Document (KIID) for each fund. You might also find that a fund has several different classes of units, each with their own charges. Typically, institutional investors, because of their humungous size, tend to enjoy lower charges.

If you buy a fund through an investment platforms it will tend to have lower annual charge, however the investment platform will also charge you for holding funds through them. Sometimes this holding charge will be based on the percentage of the amount you have invested, while others will charge a fixed fee per annum.

One negative point regarding unit trusts and OEICs is that their charges don’t tend to be reduced as the fund size grows. However, it’s not ten times more costly to run a fund worth £5bn than it is to run one worth £500m. Other types of funds, such as investment trusts and exchange traded funds (ETFs) tend to have lower charges for bigger funds and this is a major plus point in their favour.

Pricing

Unit trust and OEIC providers generally calculate their prices once a day. This is where the main difference between unit trusts and OEICs arises. With a unit trust there are generally two prices, a “bid” price and an “offer” price. Purchases are made at the offer price and sales are made at the bid price. The reason for the names is that at the offer price, they are offering units to you and, at the bid price, they are bidding to receive units from you. The difference between the two prices incorporates the “initial charge”. OEICs have only one price, with the initial charge being taken as a separate commission.

When you buy into a unit trust or OEIC your order is turned into units when the price is next set. If you make your order in the afternoon, this could therefore be the next business day. Once the transaction is completed, you will be sent a contract note. You should hang on to this.

Once your money is in the trust, it is held by the fund’s trustee for your benefit. Technically speaking, the trustee employs the management company to manage the fund according to its objectives. It is the responsibility of the trustee to ensure that this is done correctly. In the case of an OEIC, the trustee is called a “depositary”, but the effect is basically the same.


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