Unit trusts and open-ended investment companies (OEICs) are professionally managed collective investment funds. Managers pool money from many investors and buy shares, bonds, property or cash assets and other investments. An open-ended fund could be visualised as a big pool of money – the money belongs to thousands of small investors.
The fund, or pool, is divided into units. Investors can buy or sell units at any time. As people buy units, the pool gets bigger; as they sell them, it gets smaller (this is what is meant by the term ‘open-ended’). The unit price is calculated daily by working out the value of all holdings in the fund – cash, shares, bonds or whatever – and dividing it by the number of units.
A fund manager makes decisions about what to invest the money in, within the scope of the agreed investment mandate. The objective is to provide returns to the fund’s investors, either in the form of capital growth (an increase in the price per unit) or income (dividends paid to the unit holders in proportion to the number of units they hold).
The point of investing in an open-ended fund is that you believe a fund manager can make better investment decisions than you can on your own.
There are two main kinds of open-ended funds available to investors in the UK:
• Unit trusts – their units are dual-priced and there is a (higher) buy price and a (lower) sell price. If you invest in these, it is important to realise that you are in effect being charged an additional fee by the fund manager: the difference between the buy price and the sell price (sometimes called the bid and offer price)
• Open-ended investment companies (OEICs) – these have a single unit price. Most unit trusts have now been converted to OEICs
In all other important respects, unit trusts and OEICs work in exactly the same way. In fact, the term ‘unit trusts’ is sometimes used loosely to refer to both unit trusts and OEICs.
Forward pricing
Another important feature of open-ended funds is forward pricing. This mechanism means that when you place an order to buy or sell units in a fund, you will not be sure exactly what the unit price is until the deal is done.
Say the fund is priced daily at 12 noon. If you place an order at 10am on Wednesday to buy or sell units, that order will be carried out after the fund is priced at noon on Wednesday, at the new price.
If you place an order on Wednesday at 4pm, you would have to wait until Thursday at 12 noon for that order to be executed, at Thursday’s price.
The main purpose of forward pricing is to discourage short-term trading in open-ended funds, which could make life difficult for fund managers.
Investment return
Open-ended funds usually invest in shares (equities) or bonds. They may also invest in derivatives or keep money in cash, but this is mainly to help them manage their portfolios and is not usually expected to produce an investment return.
It is less common for open-ended funds to invest in physical property. This is because units can be bought or redeemed at any time. If a lot of people suddenly wanted to sell their units, it would be hard for the fund to sell properties quickly enough to pay them back.
The value of your investments can go down as well as up, and you may get back less than you invested.
Some assets are riskier than others. But higher risk also gives you the potential to earn higher returns. Before investing, make sure you understand what kind of assets the fund invests in and whether that’s a good fit for your investment goals, financial situation and attitude to risk.
