The difference between unit trusts and OEICs
These are the two of the most popular types of investment fund, but how do they differ?
Investors unable or unwilling to do the legwork of picking shares and other investments themselves often entrust this task to professional fund managers.
Generally, this involves putting money into what's known as a 'collective investment': a pool of investors' money managed by one or more fund managers. However, the most basic and cheapest of these, index tracker funds, are actually predominately run by computers.
There are many different forms of collective investment available to UK investors, but the two most common vehicles are known as unit trusts (UTs) and OEICs (Open-Ended Investment Companies; pronounced 'oiks'). While UTs and OEICs are broadly similar, there are important differences between the two.
When it comes to choosing UTs and OEICs, UK investors are spoilt for choice, with thousands scattered across all investment styles, sectors and geographies. So no matter how esoteric your investment needs, you will find unit trusts or OEICs to suit your personal portfolio.
Unit Trusts (UTs)
British unit trusts have been around for more than 80 years, with the first launched by fund management group M&G in 1931. Unit trusts are mutual funds, so their underlying assets are mutually owned by investors, with the size of individual holdings governed by how many units each investor owns.
Unlike shares, these units are not continuously priced during stock market trading hours. Instead, unit trusts issue one valuation per day per fund, commonly at noon (UK time).
Investors in unit trusts can buy into a wide range of securities, such as shares, bonds, property, commodities and so on. The value of investors' units is determined by the underlying value of the assets in their funds.
Funds are divided into equally valued units, the value of which is worked out by dividing each fund's total net asset value by the number of units. Calculating the total value of a unit trust is simple: you simply multiply the number of units by the published unit price (which usually varies from day to day).
Unit trusts are open-ended funds, which means that new units are created as fresh money flows into each fund. Conversely, when investors 'redeem' (sell) their units, the fund manager sells some underlying assets, which reduces the overall value of the fund, usually only by a tiny amount.
Investors pay no commissions to buy or sell units. However, there is a 'bid-offer spread' between the (higher) buying price of units and the (lower) selling price. Typically, this spread gobbles up around 5% to 6% of investors' money, but some low-cost funds have very low bid-offer spreads.
As well as charging investors an upfront bid-offer spread, fund managers make profits by charging an annual management charge (AMC). For most actively managed funds, this AMC costs investors around 1.5% to 2% of their fund's value each year. For low-cost funds such as index trackers, AMCs can be lower than 0.25% a year.
OEICs (Open-Ended Investment Companies)
As collective investment funds, the fundamentals of OEICs are similar to those of unit trusts. However, one key difference is that shares in OEICs have 'single pricing', which means no bid-offer spread (though recent changes now allow OEICs to offer dual pricing). So any initial charge is taken as a separate commission by your financial adviser.
Like unit trusts, OEICs have 'variable capital', so managers create new shares when money is invested and cancel existing shares when money is pulled out. Like unit trusts, OEIC funds are divided into equally valued shares that are valued daily. Again, the price of OEIC shares varies directly with the underlying net asset value of each fund.
OEICs are more modern than unit trusts, having been launched following new legislation in 1997. As OEICS are companies in their own right, each has its own board of directors, but it is the OEIC's shareholders who own each fund's underlying assets.
Buying into unit trusts and OEICs
Some OEICs and unit trusts allow you to invest as little as £25 a month or as lump sums from £250 upwards, but these minimums vary widely from fund to fund. Some funds offer 'income' units that redistribute dividends to investors (usually every six months), while others reinvest (roll up) their underlying income into 'accumulation' units.
Both unit trusts and OEICs can be bought and held inside a tax wrapper such as an ISA or personal pension. Inside these tax havens, all capital gains (from rising unit prices) and income (share dividends, bond income, etc.) attract no additional taxes. The exception is dividend income from share-based investments for higher- and additional-rate taxpayers, which is charged at a reduced rate of 10%.
When buying trust units or OEIC shares, many investors go directly to fund managers. By following this route, investors pay the full, undiscounted charges levied by each fund. Thus, this is by far their most expensive option. A far better tactic is to invest via firms that win discounts for investors, such as discount brokers or investment platform such as Hargreaves Lansdown or BestInvest.
In some cases, a unit trust's bid-offer spread of 5% to 6% can be reduced to as low as zero by investing via a discounter. Likewise, some discount brokers and investment platforms offer reduced annual management charges by rebating some of their 'trail' (ongoing) commission to investors.
Thanks to a regulatory overhaul known as the RDR (Retail Distribution Review), the UK investment industry has been undergoing an enforced revamp since 2012. In early 2014, many financial advisers and platforms launched new charging structures. While this improved fee transparency may bring down fund charges, it has also made direct comparison of fund charges trickier than ever.
So before you invest, you must always go online to compare the costs of investing in different funds via various discount brokers and investment platforms. Otherwise, you risk throwing away some of your hard-earned cash (and your future returns) by paying too much to buy into unit trusts and OEICs.
More on investing:
Beginner's guide to index tracker funds
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