Selecting a broad spread of instruments

There is a whole range of opportunities open to an investor wishing to generate extra income or build up a capital sum for the future. If appropriate to your particular requirements, one option to consider is collective investment schemes.

In the UK there are three principal types of mainstream collective or pooled investment schemes: unit trusts, investment trusts and Open-Ended Investment companies (OEICs).

All three will take the pooled monies of a large number of investors and put them in the hands of a professional fund manager. Their objective is to select a broad spread of instruments in which to invest, depending on an investment remit. The main asset classes available to invest in are shares, bonds, gilts, property and other specialist areas such as hedge funds or guaranteed funds.

There are key differences between the three types of scheme structure.

Unit trusts
Unit trusts are collective investments that allow you to participate in a wider range of investments than can normally be achieved on your own with smaller sums of money. Pooling your money with others also reduces the risk.

The unit trust fund is divided into units, each of which represents a tiny share of the overall portfolio. Each day the portfolio is valued, which determines the value of the units. When the portfolio value rises, the price of the units increases. When the portfolio value goes down, the price of the units falls.

The unit trust is run by a fund manager, or a team of managers, who will make the investment decisions. They invest in stock markets all around the world and for the more adventurous investor, there are funds investing in individual emerging markets, such as South Korea, or in the so-called BRIC economies (Brazil, Russia, India and China).

Alternatively, some funds invest in metals and natural resources, and many put their money into bonds. Some offer a blend of equities, bonds, property and cash and are known as balanced funds. If you wish to marry your profits with your principles, you can also invest in an ethical fund. Some funds do not invest directly in shares but in a number of other funds. These are known as multi-manager funds.

Most fund managers use their own judgment to assemble a portfolio of shares for their funds, which are known as actively managed funds. However, a sizeable minority of funds simply aim to replicate a particular index, such as the FTSE All-Share index. These are known as passive funds, or trackers.

Investment trusts
Investment trusts are based upon fixed amounts of capital divided into shares. This makes them closed ended, unlike the open-ended structure of unit trusts. They can be one of the easiest and most cost-effective ways to invest in the stock market. Once the capital has been divided into shares, you can purchase the shares. When an investment trust sells shares, it is not taxed on any capital gains it has made. By contrast, private investors are subject to capital gains tax when they sell shares in their own portfolio.

Another major difference between investment trusts and unit trusts is that investment trusts can borrow money for their investments, known as gearing up, whereas unit trusts cannot. Gearing up can work either to the advantage or disadvantage of investment trusts, depending on whether the stock market is rising or falling.

Investment trusts can also invest in unquoted or unlisted companies, which may not be trading on the stock exchange either because they don’t wish to or because they don’t meet the given criteria. This facility, combined with the ability to borrow money for investments, can, however, make investment trusts more volatile.

The net asset value (NAV) is the total market value of all the trust’s investments and assets minus any liabilities. The NAV per share is the net asset value of the trust divided by the number of shares in issue. The share price of an investment trust depends on the supply and demand for its shares in the stock market. This can result in the price being at a ‘discount’ or a ‘premium’ to the NAV per share.

A trust’s share price is said to be at a discount when the market price of the trust’s shares is less than the NAV per share. This means that investors are able to buy shares in the investment trust at less than the underlying stock market value of the trust’s assets.
A trust’s shares are said to be at a premium when the market price is more than the NAV per share. This means that investors are buying shares in the trust at a higher price than the underlying stock market value of the trust’s assets. The movement in discounts and premiums is a useful way to indicate the market’s perception of the potential performance of a particular trust or the market where it invests. Discounts and premiums are also one of the key differences between investment trusts and unit trusts or OEICs.

Open-Ended Investment Companies
Open-ended investment companies (OEICs) are stock market-quoted collective investment schemes. Like unit trusts and investment trusts, they invest in a variety of assets to generate a return for investors.

An OEIC (pronounced ‘oik’) is a pooled collective investment vehicle in company form. It may have an umbrella fund structure allowing for many sub-funds with different investment objectives. This means you can invest for income and growth in the same umbrella fund, moving your money from one sub fund to another as your investment priorities or circumstances change. OEICs may also offer different share classes for the same fund.

By being ‘open ended’, OEICs can expand and contract in response to demand, just like unit trusts. The share price of an OEIC is the value of all the underlying investments divided by the number of shares in issue. As an open-ended fund, the fund gets bigger and more shares are created as more people invest. The fund shrinks and shares are cancelled as people withdraw their money.

You may invest into an OEIC through a stocks and shares Individual Savings Account (ISA). Each time you invest in an OEIC fund, you will be allocated a number of shares. You can choose either income or accumulation shares, depending on whether you are looking for your investment to grow or to provide you with income, providing they are available for the fund you want to invest in.

Whatever the nature of the investments you are considering, the starting point should be to obtain professional advice. We can assess your specific needs and help you build a tailored investment plan. To discuss the options available to you, please contact us for further information.
The value of investments and the income from them can go down as well as up and you may not get back your original investment. Past performance is not an indication of future performance. Tax benefits may vary as a result of statutory change and their value will depend on individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent finance acts. Fluctuations in exchange rates can affect the sterling value of any income received.