Investment funds

Unit Trusts

Unit trusts enable investors to invest in a broad range of stocks, shares and other assets. They are “collective” investment funds, which allow investors to pool their money with other investors to form a fund that is managed by a professional fund manager. Each fund is governed by a trust deed, which establishes how it is run and its investment objectives.

Investors purchase units, which can be easily bought and sold from the fund manager. The price of units is determined by the value of the assets in the fund and will rise or fall in line with the value of those assets; prices are published daily in the press. The price at which individuals can purchase units is called the offer price, which is higher than the selling, or bid price.

In addition to offering the potential for capital growth, income from the assets owned by a unit trust is distributed regularly to unit holders. Alternatively income may be re-invested to supplement capital growth. Income, whether distributed or re-invested is liable to Income Tax.

Open Ended Investment Companies (OEICs)

OEICs became available in the 1990s and many long established unit trusts have converted their status to an OEIC over recent years.

An OEIC is a company set up specifically for the purpose of carrying out investment on behalf of its shareholders. It enables investors to invest in a broad range of stocks, shares and other assets. They are “collective” investments, which allow investors to pool their money with other investors to form a fund that is managed by a professional fund manager.

Investors purchase shares, which can be easily bought and sold from the OEIC manager. The price of shares is determined by the value of the assets in the fund and will rise or fall in line with the value of those assets; prices are published daily in the press. Unlike unit trusts, there is only one share price, however an initial charge is levied when investing and ongoing annual management charges often apply.

In addition to offering the potential for capital growth, income from the assets owned by an OEIC is distributed regularly to shareholders. Alternatively income may be re-invested to supplement capital growth. Income, whether distributed or re-invested is liable to Income Tax.

Gains made on the sale of a Unit Trust or OEIC are subject to Capital Gains Tax (CGT), however these can be set against the annual CGT allowance, which is £10,100 per person for the 2009/10 tax year.

Unit Trusts and OEICs offer a number of advantages to investors:

• They offer a simple way of benefiting from an investment in the stock market whilst avoiding the complications and many of the risks associated with a person buying and selling individual stocks and shares.
• The fund can invest in a broad spread of stocks and shares, which brings greater diversification and spread of risk.
• Each fund will benefit from the expertise of a professional fund manager who takes on the responsibility of the day to day investment decisions.
• There are many types of funds available, from low/medium risk funds such as fixed interest and corporate bond funds, through to specialist high risk funds investing in sectors such as smaller companies or specific countries.

As with any stocks and shares based investment it is recommended you take a minimum five-year view when considering Unit Trusts or OEIC investing.

Risk

Open-ended investment funds generally invest in one or more of the four asset classes – shares, bonds, property and cash. Please click here for definitions from the FSA website. Most invest primarily in shares but a wide range also invest in bonds. Few invest principally in property or cash deposits. Some funds will spread the investment and have, for example, some holdings in shares and some in bonds. This can be useful if you are only taking out one investment and – remembering that asset allocation is the key to successful investment – you want to spread your investment across different asset classes.

The level of risk will depend on the underlying investments and how well diversified the open-ended investment fund is. For example, a fund which invests only in one industrial sector, such as technology, will invariably be more risky than funds that invest across the whole range of companies in a market. Similarly funds are grouped in categories, such as UK Equity or Gilt and Fixed Interest, to make your selection process easier.

Some funds might also invest in derivatives, which may make a fund more risky. However, fund managers often buy derivatives to help offset the risk involved in owning assets or in holding assets valued in other currencies.

Any money in an open-ended investment fund is protected by a trustee or depository who ensures the management company is acting in the investors' best interests at all times.

Charges

When you buy units in a fund, you usually pay an initial charge. For some funds, you buy units at the offer price and sell them at the bid price. The bid price is lower than the offer price and the difference is called the bid/offer spread. These funds are referred to as being dual priced. The initial charge is usually part of the bid/offer spread, which can often be around 5% – so effectively 5% of your investment is taken in charges at the outset. Some funds have no initial charge, but there may be an exit charge instead when you withdraw your money by selling units.

For many funds, there is no difference between the buying and selling price of units. Because of this, the funds are referred to as being single priced. If there is an initial charge, it is added to the single price when you buy units, and there may also be an exit charge when you sell units. Between them, these charges are likely to represent around 5% of your investment, so you may end up paying the same level of charges in a single-priced fund as in a dual-priced fund.

The fund management company takes an annual management charge directly from the investment fund. There are also other costs – buying and selling within the fund, custodian fees etc. These costs, along with the annual management fee, are called the total expense ratio (TER). The TER is therefore an estimate of the total ongoing costs of the investment.

Tax

For income, there is a difference in the tax position between funds investing in shares and those investing in bonds, property and cash.

• Income (dividends) paid by shares within an open-ended investment fund is assumed to be paid after taking 10% tax (the tax credit). These dividends, when paid out of the fund to you, are not subject to any tax if you are a basic-rate or non-taxpayer. If you are a higher-rate taxpayer then you have an overall tax rate on dividends of 32.5% of the gross dividend (but you can deduct the 10% tax credit). Non-taxpayers cannot reclaim this 10% tax credit.
• Income paid by bonds, property or cash within an open-ended investment fund is paid net of 20% tax. For funds investing principally in these asset classes, no further tax is due if you are a basic-rate or non-taxpayer. If you are a higher rate taxpayer then you will have to pay an additional 20% tax. However, unlike funds investing in shares, if you are a non-taxpayer then you can reclaim the appropriate amount of tax paid.

Whichever type of open-ended investment fund you have, you can reinvest the income to provide additional capital growth, but the taxation implications are as if you had received the dividend income.

No capital gains tax (CGT) is paid on the gains made on investments held within the fund. But, when you sell, you may have to pay capital gains tax. However, bearing in mind that a personal CGT allowance (£10,100 for the 2009/10 tax year per individual) is available, it is often possible to avoid all CGT.

Please note that this is only a summary of the tax position at April 2009. You should be aware that tax legislation changes constantly and you should find out the most current position.

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