Guide to Unit Trusts and OEICs

Most people choose to invest in an investment fund rather than buying shares directly on the stock market.

There are many different types of funds. Some, like investment trusts and exchange-traded funds (ETFs), are traded on the stock market and can be bought and sold via a stock broker.

Others, such as unit trusts, insurance and pension funds, can be either bought directly from the company that runs them or via a discount broker, fund supermarket, or Independent Financial Adviser.

To start, we’re going to look at unit trusts, and open-ended investment companies (OEICs).

What are OEICs and unit trusts?

These two types of funds operate in a very similar fashion, which is why they are often grouped together.

Over the last few years, many companies have been converting their unit trusts into OEICs, mainly for technical and administrative reasons. (Note that OEICs are sometimes also called ICVCs, which stands for investment companies with variable capital.)

There are a few thousand unit trusts and OEICs in existence at the moment. These funds are provided by around 100 different companies, some of the largest managers being Fidelity, Invesco Perpetual, Legal & General, and Schroders.

These funds are usually divided into geographical sectors, such as the UK, US, Europe, Asia, global, etc. Further sub-divisions are often made into growth, income or smaller companies funds, or funds that specialise in particular sectors, such as mining or biotech.

However, these categories are only rough guides, and it is often possible for two very different types of funds to be grouped together in the same sub-category.

Unit trusts explained

Unit trusts allow investors to pool their capital with other investors to collectively increase the buying power of the group. As such, previously unaffordable investments into stocks and shares, real estate, or fixed interest become affordable.

Typically, these are designed as medium- to long-term investment instruments.

OEICs explained

OEICs work almost identically to unit trusts. However, they are structured as a company rather than a trust and are therefore governed by different regulations.

OEIC investors have a claim on the company’s underlying assets, whereas investors in a trust do not.

How do unit trusts and OEICs work?

Unit trusts and OEICs are both known as “open-ended”, because their size is not limited.

Imagine that you have £10,000 invested in a unit trust with a total of £10m of assets. If you decided to withdraw your investment, then the fund’s total assets would go down to £9,990,000. However, if you decided instead to add another £10,000 to your investment, then the total assets would go up to £10,010,000.

The effect of this is that if a fund suffers a large number of redemptions (that is, withdrawals), then it will have to sell some of its investments in order to provide the money for the investors who are pulling out.

Similarly, when lots of people are adding money to a unit trust, that trust has to buy more investments in order to maintain its investment profile.

Although it is hard to say how significant this effect is, it generally has a net negative effect on investors, as it means shares are bought and sold on a frequent basis, and this incurs transaction costs.

What’s the difference between unit trusts and OEICs?

A unit trust and an OEIC are functionally almost identical. They are both open-ended, with the price of each unit or share is directly tied to the net asset value of the fund’s investment portfolio. But there are two key differences.

1.     Structure

As the names suggest, an OEIC is structured as a company, whereas a unit trust is structured as a trust. 

To most investors, the difference is negligible. However, from a legal perspective, it can be quite significant. As investors in a company, shareholders of an OEIC are owners of the group’s underlying assets. This is not the case for investors in a unit trust.

2.     Pricing

Another big difference between unit trusts and OEICs is pricing.

With a unit trust, there are generally two prices, a ‘bid’ price and an ‘offer’ price. Purchases are made at the offer price, and sales are made at the bid price.

The reason for the names is that at the offer price, they are offering units to you, and at the bid price, they are bidding to receive units from you. The difference between the two prices incorporates the ‘initial charge’. OEICs have only one price, with the initial charge being taken as a separate commission.

When you buy into a unit trust or OEIC, your order is turned into units when the price is next set. If you make your order in the afternoon, this could be the next business day. Once the transaction is completed, you will be sent a contract note. You should hang on to this.

Once your money is in the trust, it is held by the fund’s trustee for your benefit. Technically speaking, the trustee employs the management company to manage the fund according to its objectives. It is the responsibility of the trustee to ensure that this is done correctly. In the case of an OEIC, the trustee is called a ‘depositary’, but the effect is basically the same.

How much can you invest in OEICs and unit trusts?

As a general guide, the minimum amount you can invest in a unit trust or OEIC is £500 in a lump sum or £50 per month, but it varies from fund to fund.

Many funds have ‘income’ and ‘accumulation’ units. Income units pay you a dividend, usually twice a year. Accumulation units automatically reinvest your dividends back into the same fund. Note that whichever type of unit you choose, the dividend is treated the same for tax purposes.

Can OEICs and unit trusts trade on the London Stock Exchange?

No. Although OEICs are structured as a company, they cannot be traded on the London Stock Exchange. Instead, the price per share of an OEIC is determined once per day based on the net asset value of its investment portfolio.

Similarly, unit trusts are also not listed on the London Stock Exchange. The price per unit is also based on the net asset value of its investment portfolio. However, unlike an OEIC, a unit trust will always quote two prices, the previously mentioned bid and offer prices.

• Bid – the price per unit when selling
• Offer – the price per unit when buying

The increased complications introduced by a trust’s structure result in higher fees compared to an OEIC. This is one of the main reasons why the latter has gained greater popularity in recent years.

Taxation of unit trusts and OEICs

Neither unit trusts nor OEIC are tax-free investment instruments. Therefore, investors will be subject to dividend tax and capital gains tax on any income received that exceeds the personal allowances.

However, holding these assets inside a tax-efficient account like an ISA can turn these into tax-free investments.

Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.

Charges for unit trusts and OEICs

With unit trusts and OEICs, you have to watch out for both initial charges and annual charges. And just to add to the confusion, both of these charges will vary depending on who you actually buy the fund from.

Initial charges

Initial charges are typically 5%, often because part of this is used to pay an adviser a commission when you put your money into a fund. However, you can often get a much lower initial charge (sometimes as low as zero) by buying via a discount broker or fund supermarket. Somewhat perversely, buying a unit trust or OEIC directly from the company that provides it is often the most expensive option.

Annual charges

Annual costs are typically in the region of 1%-1.5%. Index-tracking funds and funds that invest in corporate bonds are usually slightly cheaper.

As with all funds, look at the Ongoing Charge Figure (OCF) rather than just the annual management charge if you want the fairest comparison of the cost of two or more funds. The OCF should include additional costs, like audit and trustee fees, which aren’t included in the annual management charge.

You can usually find this information in the Key Investor Information Document (KIID) for each fund. 

Other charges

You might also find that a fund has several different classes of units, each with its own charges. Typically, institutional investors, because of their humungous size, tend to enjoy lower charges.

Buying a fund through an investment platform will tend to have a lower annual charge. However, the investment platform will also charge you for holding funds through them. Sometimes this holding charge will be based on the percentage of your invested amount, while others will charge a fixed fee per annum.

One negative point regarding unit trusts and OEICs is that their charges don’t tend to be reduced as the fund size grows. However, it’s not 10 times more costly to run a fund worth £5bn than it is to run one worth £500m.

Other types of funds, such as investment trusts and ETFs, tend to have lower charges for bigger funds, which is a major plus point in their favour.

Pros and cons of investing in OEICs and unit trusts

Is investing in OEICs and unit trusts right for you?

Investing in an OEIC or unit trust has its advantages. And for a long-term investor who isn’t interested or able to spend time researching investments, these instruments serve as a viable method of putting a portfolio on auto-pilot.

However, historically, the average performance of these investment vehicles has lagged behind indexes like the FTSE 100 and FTSE 250 after management fees have been deducted. A few with a talented fund manager at the helm have outperformed. But identifying these can be quite tricky.

For investors willing to take on more risk, OEICs and unit trusts open the door to the possibility of outperforming the stock market without having to pick individual stocks directly.