Unit Trust Guide
The unit trust industry has come a long way since its modest beginnings in 1931, when M&G launched the first unit trust. Today the industry manages £3 trillion in over 2,000 funds across over 30 different investment sectors. Collectively known as investment funds, unit trusts and Oeics (pronounce ‘oiks’) continue to be the most popular ways for ordinary investors to access world stock markets.
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Investment funds are a bit like investment clubs. You pool your money with that of other investors and the whole lot is invested collectively on your behalf by a professional fund manager.
This enables you to gain access to a wider range of shares than would be possible if you were investing on your own. The fund manager will manage the money according to specific criteria such as investing in a particular industrial sector, in a specific investment style, geographical region or to produce growth or income.
You buy a share in an investment 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 (published on websites and in financial publications each day), by the number of units you own. Both unit trusts and Oeics are known as ‘open ended’ funds because the fund manager can create more ‘units’ on demand. Use our: Unit trusts & oeics A-Z|Back to Top
Initial charges range from 5-6 per cent and annual management charges (AMCs) from 0.5- 2 per cent, depending on the type of fund and degree of specialist management and research required.
For instance, index tracker funds tend to be the cheapest as they are run passively, without much management input needed, so that AMCs on tracker funds can be a low as 0.3 per cent. An esoteric fund invested overseas could have an AMC of up to 2 per cent. Use our: Unit trusts & oeics A-Z|Back to Top
You can buy directly from a fund management house, a discount broker, an online fund supermarket or via an independent financial adviser (IFA). Which of the above distribution channels you use will have a bearing on costs. Usually it is also cheaper to buy a fund within an ISA than without the ISA wrapper. This is because most fund managers offer discounts on ISAs as a way of boosting business in the ‘ISA season’ – typically in the three months up to the end of the tax year.
The worst thing you can do is to buy directly from the fund management company, as you will pay maximum charges, whereas if you buy via a discount broker or fund supermarket, you will normally be given a 2-3 per cent discount off the initial charge. Buying via a fund supermarket is also cheaper for subsequent fund switches, so this is a good way of holding your investments if you have a large number of funds and want to actively manage your investments. The table below shows what it might cost you to buy the popular Invesco Perpetual Income fund via different channels: Use our: Unit trusts & oeics A-Z|Back to Top
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||Initial charge %
||Annual management charge %|
|Direct from Invesco Perpetual (non ISA)
|Direct from Invesco Perpetual (ISA)
|Fund supermarket in an ISA
|IFA in an ISA [discounts negotiable]
|IFA (non ISA: discounts negotiable)
In addition to the initial and annual management charges, there are other hidden charges for custody, administration and trusteeship. These are reflected in the total expense ratio (TER) which is a more realistic reflection of the total charges. TERs can range from 1.7-3 per cent, depending on the type of fund you choose. For specialist funds and ‘fund of funds’ (using external funds), the TER could be as high as 2.5-3 per cent. (Source: Lipper).
TERs are important because a fund quoting an initial charge of, say, 1.5 per cent might have a TER of 1.8 per cent. Clearly, funds with high TERs have to work that much harder to produce a decent return, net of all charges. Use our: Unit trusts & oeics A-Z|Back to Top
When you buy or sell an investment fund, 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 set the following day at 3pm. Use our: Unit trusts & oeics A-Z|Back to Top
Unit trusts are dual-priced. This means that you buy at the ‘offer’ price and sell at the ‘bid’ price. The offer price is around 5-7 per cent more than the bid price. The difference between the two is known as the ‘spread.’ Oeics were launched in the mid 1990s, promising a single-priced charging structure that would be 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 bid/offer spread, but this is because it is simply hidden. An Oeic’s single share price is effectively the mid-value between the offer and bid prices of the underlying fund. Use our: Unit trusts & oeics A-Z|Back to Top
The spread between the bid and offer price is usually around 5-7 per cent, but unit trust groups are permitted to widen this gap to as much as 10 per cent if there is a run on a fund. When there are far more sellers than buyers, the fund manager is allowed to shift the bid price towards the higher end of the bid/offer spread (ie charge the maximum of 10 per cent) as means to deter investors from selling out of the fund.
So what happens with Oeics which have 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. Use our: Unit trusts & oeics A-Z|Back to Top
Many ordinary investors make their first investment in unit trusts and Oeics via a regular saving scheme. This means committing to save the same amount each month, which can be as little as £20, but most funds require a minimum monthly contribution of £50. For lump sums, the minimum is usually £500.
Regular investment can be beneficial in certain circumstances because of the effect of what is known as ‘pound/cost averaging.’ This is the mechanism whereby your regular investment will benefit from stock market dips because your money will buy more units in the fund when the unit price is low. Assuming that the unit price eventually rises in value, you will benefit from having extra units. More importantly, by saving regularly, you don’t have to worry about market timing – namely that you invest at the ‘wrong’ time. The hope is that pound/cost averaging will even out the peaks and troughs over time. Use our: Unit trusts & oeics A-Z|Back to Top
If you want to switch to a fund run by a different fund manager, you will normally 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 do this with a 2-3 per cent discount on the initial charge.
If you expect to switch in and out of funds frequently, the most cost effective way to hold your investments is on a fund supermarket. You will be able to switch at a discount of 2-3 per cent off the normal initial charges. The amount you actually pay for switching will depend on the discounts which the fund supermarket has negotiated with the various fund management groups whose funds it offers. Some give more generous discounts than others, or not at all. Use our: Unit trusts & oeics A-Z|Back to Top
To check how your funds are performing, you can check the unit prices listed in newspapers like the Financial Times, on the fund manager’s website or on websites such as Trustnet.co.uk. You will also receive interim and annual reports each year from the fund management group. These will include information on how the fund has performed, details of the portfolio, investment changes and a report from the manager.
Performance figures may be quoted on a ‘bid to bid’ basis or on a ‘performance net of charges basis,’ referred to as ‘offer to bid.’ There are two ways of showing long term performance: in discrete years and 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 consistent performance over the long term. While some people look to the fund manager’s past performance when picking a fund, remember that ‘past performance is no guarantee of future performance.’ Use our: Unit trusts & oeics A-Z|Back to Top
Investment in unit trusts and Oeics may give rise to both income and capital gains tax liabilities. Income is taxed at 32.5 per cent. Capital gains on the sale of unit trusts and Oeics in excess of your annual capital gains tax allowance (£9,600 in 2008-09) are liable to a flat rate of CGT at 18 per cent. If you hold investment funds within an ISA or any type of pension scheme such as a Sipp, you have no further liability to capital gains tax or income tax.
For more information, check the following websites: Investmentuk.org and Trustnet.co.uk
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Last updated 20 January 2009