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Unit Trusts
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Unit trusts are collective investment funds that invest mainly in shares, aiming to generate returns through capital growth or income or a mix of the two. Unit trusts are similar to Open-Ended Investment Companies (OEICS) but have some key differences.
- What are unit trusts?
- What do unit trusts invest in?
- How much is investing in unit trusts going to cost me?
- How risky are unit trusts?
- Are unit trusts better than investment trusts?
- Are unit trusts like an ISA or a PEP?
- What happens if I want to cash in my unit trusts quickly?
- How do I find the best performing unit trust?
- Where can I get further information on unit trusts?
What are unit trusts?
Unit trusts are open ended, collective investments. A unit trust is open ended because the number of 'units' in each trust will vary according to supply and demand. It is collective because it puts together monies from many different investors which is then looked after by a professional investment manager. It is the job of the fund manager running unit trusts to make sure the money is invested properly and to deliver to investors the very best returns given market conditions.
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What do unit trusts invest in?
Most unit trusts use the money given to them by unit holders to buy ordinary shares, or equities, but there are a great many different types from which to choose. According to industry body the Investment Management Association there were 2,080 UK-domiciled funds on offer to investors in April 2007 and a further 506 foreign-domiciled funds (of the UK funds, 1,329 were OEICs and 751 were unit trusts, source: IMA 04/06/07).
Some unit trusts are very general and hold a large number of shares in different companies, spreading investments into overseas companies in some cases. Others are more specialised, giving the unit holders access to a particular geographic area or particular type of investment by industry sector.
It is important to decide what level of risk you want to take before choosing unit trusts. In any event though, unit trusts are a way of spreading risk across a larger number of ordinary shares than might otherwise be possible.
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How much is investing in unit trusts going to cost me?
No-one works for nothing, so there are charges involved in buying unit trusts. Most management companies charge a 'one-off' fee as soon as they receive your money. This upfront charge can range from as little as 0.5% to as much as 6%. Some fund managers have scrapped their front end charges in favour of exit charges for investors who remain invested for just a few years. All unit trust managers charge an annual fee which can vary from as little as 0.75% to as much as 2%.
Often these fees will reflect the costs associated with investing in a particular area, so unit trusts investing overseas, especially in obscure or developing markets, tend to be more expensive than unit trusts buying just UK shares. It can pay to shop around, some management companies will be more efficient than others at pegging costs.
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How risky are unit trusts?
As risky as you want to make them, it depends how much risk you choose! Remember you are investing in funds that are linked to the stock market. Your capital is not secure and your income will not be guaranteed.
With so many unit trusts to choose from, you will not be surprised to learn that some are riskier than others. Invest in unit trusts buying small company shares in a little known foreign market, and you are making a risky investment. Invest in one with a wide spread of leading, blue chip companies, and the risk is likely to be a great deal smaller.
You need to understand the amount of risk you are taking by investing in different unit trusts. Most investment management companies will give you a guide to the risk profile of their unit trusts. Your independent financial adviser (IFA) should be able to give you valuable advice on which unit trusts fit your views on risk and return.
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Are unit trusts better than investment trusts?
They are certainly different! Both are collective investments, but investment trusts are closed ended. That is to say the number of shares in issue is fixed. As a consequence, the price may go up and down not in direct relation to the value of the underlying assets, unlike a unit trust where the unit price fluctuates depending on the value of the investments held by the trust.
Moreover, an investment trust may borrow money to invest on behalf of its shareholders. This can provide a boost to investment performance when markets are rising. However, equally, when they're falling, the falls will be exaggerated. Another difference is that investment trusts are permitted to invest in unquoted shares which again can add to the risk for investors, even if the potential rewards might be greater.
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Are unit trusts like an ISA or a PEP?
Let's not get confused. An Individual Savings Account (ISA) and its predecessor the Personal Equity Plan (PEP) are nothing more than umbrellas that allow you to benefit from investments in a tax-advantaged manner. Unit trusts may be bought and then held within an ISA so as to maximise the tax benefits from holding them.
In other words, an ISA is a tax efficient way of holding investments. Rather confusingly, many fund management groups offer exactly the same investments as unit trusts and directly as ISA investments, sometimes charging lower fees for the latter.
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What happens if I want to cash in my unit trusts quickly?
Unit trusts are investments in the stock market. Therefore, they should not be considered a short term investment. Typically you should be prepared to leave the money invested for at least five years, although you may find the stock market moves in the intervening period - this may allow you an opportunity to cash in at a useful profit.
Remember most unit trusts will charge a front end fee so you need to hold the investments for a little while to recoup your expenses. Unit trust funds that charge an 'exit' fee tend only to do so for investors who want to cash in within five years. Most unit trusts require a minimum lump sum investment ranging from £500 to £1000, although there are regular savings schemes that allow smaller amounts to be put in each month. Unit trusts usually deal every day on unit prices established using the previous day's asset values.
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How do I find the best performing unit trust?
Past performance is not an indication or guarantee of future returns. You will see these words or a phrase like this prominently alongside much larger advertising claims about how well a fund has done in the past.
Charges can also affect the return you are likely to get from unit trusts. While funds with lower initial and annual fees may or may not outperform those with higher fees, do remember that a fund with a higher charge has to outperform as an investment just to match a given level of return. You need to check out all the charges before you decide which unit trusts to buy - charges can have a major impact on the performance of a unit trust.
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Where can I get further information on unit trusts?
The Investment Management Association, which is the trade body for fund managers running unit trusts, offers a range of introductory literature on its website or available in hard copy.
Most unit trust companies themselves will have product literature, although, if you are not used to investing, you may find some of the terminology confusing. Your independent financial adviser will also be able to tell you more and explain the advantages and pitfalls of investing in unit trusts.
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25 July 2007 © Moneyextra.com
Our senior editor Robin Amlôt recommends you should consider taking independent financial advice before acting on any article. Please contact us for help with your individual circumstances if any assistance is required.