Guide to unit trusts and OEICS
A massive £468 billion is invested in unit trusts and Oeics - collectively known as investment funds - and these continue to be two of the most popular ways for people to invest in world stock markets.
Unit trusts and Oeics are like investment clubs, whereby a group of investors pool their money so that it can be invested collectively in the stockmarket. This enables ordinary investors to gain access to a wider range of shares than would be possible if they were investing on their own.
Your money is invested on your behalf by a professional investment manager who may have a mandate to invest according to certain criteria such as being restricted to choosing shares, based on a certain country/ies, sectors or investment styles.
An Oeic, incidentally, stands for Open Ended Investment Company, and is pronounced ‘oik,’ as in an uncouth youth.
Unit trusts (increasingly known as mutual funds) and Oeics are simple to understand. You buy a share in the fund by purchasing units which reflect the value of the underlying investments. To work out how much your fund is worth, you multiply the unit price by the number of units you own.
Both these types of investment fund are known as ‘open ended’ funds because the fund manager can create more units or shares on demand.
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What are the charges?
Unit trusts and Oeics have an initial charge of between around 2-6 per cent and an annual management charge of between around 0.5- 2 per cent.
You can buy investment funds directly from the fund management company, a discount broker or an online fund supermarket. Where you buy will have a considerable impact on how much you pay in charges, so bear this in mind before investing and remember that you can usually buy a fund more cheaply within an Individual Savings Account or ISA/ wrapper.
Also, if you buy direct from the fund manager you will pay the same, if not higher, charges than if you buy via an independent financial adviser or discount broker. Any IFA worth his salt should give you a rebate of 1-3 per cent off the initial charge.
The table below shows what it might cost you to buy the popular Invesco Perpetual Income fund via different channels:
Typical costs for purchasing unit trusts
||Initial charge %
||Annual management charge %|
|Direct from Invesco Perpetual (non Isa)
|Direct from Invesco Perpetual (Isa)
|Discount broker such as Chartwell Direct(both Isa and non-Isa)
|Fund supermarket – FundsNetwork (non Isa)
|Fund supermarket – FundsNetwork (Isa)
Total expense ratio
However, there are other charges which you should be aware of which make up the ‘total expense ratio.’ This reflects the total cost of the charges (annual management, custody, administration, trusteeship and so on). This means that the TER is often considerably higher than the stated annual management charge(AMC).
TERs for ordinary investment funds investing in the UK equity funds can range from 1.7 -3 per cent, whereas the average TER for a UK equity fund of funds (using internal funds only) is around 1.8 per cent. The average for a UK equity fund of funds (using external funds) is around 2.5 per cent. (Source: Lipper).
TERs are calculated by examining the last annual report and accounts of the fund manager, taking into account charges that are not included in the stated annual management charge. These can show that a fund with a stated annual management charge of, say, 1.5 per cent is actually costing you 1.8 per cent.
Clearly, such a high level of charges means that funds, which have a double layer of charges (such as multi manager and fund of funds), need to work very hard to give a decent return, net of all charges.
When you deal, you will usually pay the price set at the next available price point, a mechanism known as ‘forward pricing’. This means that if the price point for the fund is 3pm and your order goes through at 4pm, you will pay the price which is set the following afternoon.
What’s the difference between a unit trust and an Oeic?
The units of a unit trust are dual-priced. This means that you, the investor, buy at the ‘offer’ price and sell at the ‘bid’ price. The offer price is around 6-7 per cent more than the bid price.
With unit trusts, the initial charge is reflected in the difference between the buying and selling prices, known as the ‘spread’. With Oeics, there is no spread, so any initial charge is deducted from your initial investment, with the remainder being used to buy shares.
Oeics were launched in the mid-1990s, promising a single-priced share structure that would make it easier for ordinary investors to understand. In practice, having single-priced funds made it easier for UK-based fund management groups to sell their investment funds in Europe.
They may pretend that there is no nasty bid/offer spread to worry about, but in fact this is simply hidden - an Oeic’s single share price is effectively the mid-value between the offer and bid prices of the underlying investments.
What does 'moving to a bid basis' mean?
The spread between the offer and the bid price is usually around 6-7 per cent, but unit trust groups are permitted to widen this gap to as much as 10 per cent at times of extreme market volatility.
When this occurs and there are far more sellers than buyers, the fund manager is allowed to shift the price closer towards the higher end of the bid/offer spread (ie charge the maximum of 10 per cent) as a means of discouraging investors from selling out of the fund.
So what happens in this situation if you are invested in an Oeic which has a ‘single’ price? Well, again, if too many people are cashing in their chips, the fund manager can impose a ‘dilution levy’ of a few per cent to protect the interests of the remaining shareholders. So just like a unit trust moving to a bid basis, a dilution levy on an Oeic makes selling out more expensive.
How do I choose between the different sectors?
There are nearly 2,000 unit trusts and Oeics, split into 33 sectors, which reflect the geographical area, asset class, or investment style such as whether the fund is income, growth, specialist, managed, balanced, target, aggressive, ethical or index tracking. The criteria for each sector are laid down by the Investment Management Association (IMA) (www.ima.org.uk)
In some cases, funds only just meet their sector definitions, so it’s worth taking a close look at the fund’s portfoil before you invest. For details of funds visit our Investor Centre: http://www.find.co.uk/my_find/pic
How do I choose a fund?
When investing in collective funds, there is a whole host of factors which could influence where you invest, such as whether you want income or growth, UK or international exposure, active or passive management, large or small cap stocks and so on.
Funds that track the stock market index, known as index tracking or passive funds, are far cheaper than actively managed funds.
Actively managed funds can charge up to three times more than a passively managed fund because you are paying (supposedly) for the fund manager’s superior stock picking skills. In practice, however, surveys shows that only a quarter of actively managed funds regularly outperform index tracking funds.
Some of the best performing actively managed funds are ones that focus on dividend income. This is because dividend income is more certain and UK companies have a strong record of increasing dividends each year.
Betting on the growth in the capital value of a bundle of shares is more difficult to get right, and while growth funds may shoot the lights out during stockmarket booms, they can equally plummet just as fast in a bear market.
There are also hundreds of international funds investing in most countries around the world, including North America, Europe and the Pacific region, with many more narrowly based funds investing in emerging markets, and even single country funds.
Specialist funds often invest in one sector or ‘theme,’ such as technology, media, healthcare, pharmaceuticals, commodities or commercial property.
In recent years, some fund management groups have launched a raft of new funds such as ‘guaranteed,’ ‘protected’ and ‘structured’ funds which use derivatives as a means of locking in returns.
Different investment styles
You can obtain a large amount of information about a fund you are interested in from the fund manager’s website. This will often show details of the fund’s past performance, a pie chart of the investment portfolio and the top 10 largest stocks in the portfolio.
But you may have to dig deeper to find out exactly how the fund manager invests. For instance, there are a number of different index tracking styles. Index tracking can be done through ‘full replication,’ which means the fund manager actually buys each component share in the index, but this can be difficult to do in practice and is quite rare.
It is more likely to be done via ‘strategic sampling.’ This involves the fund manager buying a range of companies which reflect the make up of the index, while buying market tracking derivatives to improve replication.
The key thing to watch out for with index tracking funds is the fund’s ‘tracking error ’ – namely, the percentage deviation from the index’s performance. A reasonable level of deviation from the index is 1 per cent. If it is more than that, the fund manager is failing to capture the market’s performance for some reason.
Active fund managers used to divide into ‘growth’ or ‘value.’ Growth is where the fund manager identifies companies whose share price is set to outperform the rest of the market.
By contrast, ‘value’ investors look for opportunities among well-established companies whose share price the fund manager thinks is undervalued. However, the distinction nowadays is not always that clear cut and many managers employ both styles.
An increasing number of fund managers offer funds run according to ‘ethical,’ ‘environmental’ or ‘Socially Responsible Investment (SRI)’ criteria. These funds have widely varying definitions of what they regard as green or ethical, so it is worth checking the specific remit of a fund before investing.
More recent techniques have included a form of ‘concentrated’ fund management, whereby the fund manager runs a tight portfolio of just 20-30 holdings.
This is fine if you believe in the manager’s skills, but the whole point of investment funds is to provide ordinary investors with a wide spread of investments to reduce risk, which is why investment regulations impose an absolute minimum of 13 stocks per fund.
A small number of fund managers are taking advantage of recent legislation allowing them to use derivatives and investment techniques such as ‘shorting,’ which are widely used by hedge fund managers.
‘Shorting’ involves the fund manager borrowing a share from a financial institution such as a pension fund and selling it quickly in the hope that it will fall in price so that it can be re-purchased at a lower price. The opposite of shorting is ‘long only’ investing.
'Fund of funds’ is where a fund manager puts together a range of in-house funds to form a portfolio. The idea is that by having a wide range of funds, investment risk is spread across different asset classes and investment styles. However, net returns have not been great and the charges can be high.
‘Multi-management involves a fund manager offering a collection of funds based on a range of different asset classes, sectors, fund management styles and external fund managers.
However wonderful this concept may seem in theory, remember that these can be expensive as you are effectively paying for two layers of management – the fund manager’s and those of the external fund managers.
Regular saving or lump sum?
Many ordinary investors make their first investment in unit trusts and Oeics via a regular saving scheme. This means investing the same amount each month, which can be as little as £20, but most funds have a minimum monthly contribution of £50. For those who have a lump sum to invest, the minimum is usually £500.
Much is made of how those investing small amounts regularly can benefit from what is known as ‘pound/cost averaging.’ This is because if the market falls, your regular contribution will buy more units because the unit price is low. If the units subsequently rise in value over time, your holding will clearly be worth more.
More importantly, a regular saving scheme means that you don’t have to worry about market timing – namely that you are investing at the ‘wrong’ time. The hope is that pound/cost averaging will even out the peaks and troughs over time.
If you want to change fund manager, you will incur costs in the form of fresh initial and annual management charges. If you are simply switching money between funds run by the same fund manager, you should be able to secure a discount on the initial charge, or you may be offered a number of free switches a year.
To check how your fund is doing, you can see the unit prices listed in the Financial Times or on your fund manager’s website. You will also receive two reports a year from the manager, an interim and an annual report.
These will show how the fund has performed and list details of portfolio changes, as well as provide a report from the manager. But to find out how your fund is doing against others, and against sector comparators, visit www.trustnet.co.uk
When looking at performance figures you need to be aware of whether it is shown on a bid to bid basis or on a performance, net of charges, basis, namely offer to bid.
Also, there are two ways of showing performance over time: in discrete years or cumulative years. Remember that a fund’s performance may look great over the short term, but this could be due to luck or a particular market event which is not a reflection of the fund manager’s skill.
Most ordinary investors want to see consistent performance over the long term, even though fund managers never cease to tell us that ‘past performance is no guarantee of future performance.’
Should I follow a star fund manager?
Regrettably, the best fund managers are often headhunted by other firms so that you may find that the ‘star’ manager, who was in charge of your fund at the outset, has moved to a rival fund management group.
Opinion is divided as to whether you should ‘follow the manager’ or stay put. Much depends on to what extent the good performance was due solely to the individual or whether it was a team effort. An IFA who specialises in investment should be able to advise you on the best course of action in each case.
If you are investing in unit trusts or Oeics, you may be liable to both income and capital gains tax. Any gains in excess of your annual capital gains tax allowance will be liable to CGT. Dividend income will be liable to income tax, but you should seek tax advice on your liability.
If you hold your unit trusts or Oeics within an ISA, there is no liability to capital gains tax. As for income tax, since the abolition of tax credits on dividends in 1997, there is only a 10 per cent tax credit on dividend income. However, interest deriving from fixed interest and cash, still receives a tax credit of 20 per cent.
It is also possible to obtain tax credits on dividend income when investing in distribution funds via an ISA, providing the fund is at least 60 per cent invested in fixed interest assets, such as corporate bonds or gilts.
What if things go wrong?
Write to the fund management company setting out your complaint. Each company authorised by the Financial Services Authority (FSA) must have a compliance officer whose job it is to ensure that the group complies with FSA regulations. You should receive a reply within eight weeks.
If the reply you receive is unsatisfactory, you have six months in which to take your complaint to the Financial Ombudsman Service. Before doing so, you will need a letter from the fund management company confirming that you have exhausted its internal complaints procedure. This is called a letter of deadlock.
Financial Omdudsman Service0845 080 1800email: firstname.lastname@example.org to:The Financial Ombudsman ServiceSouth Quay Plaza183 Marsh WallLondon E14 9SR