Investing In Unit Trusts, OEIC and Mutual Funds
How to Invest in Unit Trusts and OEIC (similar to Mutual Funds)
What are Unit Trusts and OEIC and why should you invest in them?
This article is all about the advantages (and disadvantages) of these very popular equity investments, how to invest in Unit Trusts and OEICs (Open Ended Investment Companies which are effectively the same as Unit Trusts) and the pros and cons versus the alternative collective investments or individual shares. They are generally recommended by Financial Advisors to investors who want a managed collective investment in shares, bonds or commodities and who don't want to or don't have sufficient funds to invest in individual shares etc., but there are alternatives, such as investment trusts and ETFs with much lower charges. There are however ways of reducing the cost making UTs/OEICs a viable investment.
There are a huge number of unit trusts/OEICs from several investment groups, such as Black Rock, Foreign and Colonial (F&C), Fidelity, Gartmore, Henderson, Invesco, JP Morgan, Jupiter, M&G, New Star etc. many of whom also have similar products sold as an investment trust.
Disclaimer: Information in this and other linked articles is unregulated and for general information only and is not intended to be relied upon in making specific investment decisions. Appropriate independent advice should be obtained before making any such decision.
Pros and Cons of UTs and OEICs
Advantages of Unit Trusts...
Unit Trusts and OEIC, unlike Investment Trusts (ITs) are made up of units each representing a mini portfolio of shares, bonds, commodities and each time a unit is purchased or sold the investment manager must increase or decrease his investment accordingly (ITs are companies with a fixed number of shares and it is the shares that are traded and are subject to supply and demand price changes) The value of a UT/OEIC therefore exactly represents the underlying market, whereas an IT may trade at a discount or premium to its net asset value (NAV)
UT/OEICs can only be traded on a daily basis, with one price being quoted for the whole day and it will be tomorrow's price you buy or sell at, whereas ITs trade continuously throughout the trading day.
If you want to buy an investment trust through a broker they will charge you a fee, of typically about Â£10 and, as they are actually a share in a company, you will also need to pay 0.5% stamp duty. Neither of these fees are payable when buying a UT, although you do have the big, typically 5%, and upfront fee. If, however you buy direct from the management company (e.g. Fidelity, Foreign and Colonial etc.) they will have low cost ISA and regular saver options which may even be free apart from the stamp-duty. There are also now money supermarkets and discount brokers (e.g. Hargreaves Lansdown) who will give back most of the 5% upfront fee and some of the annual management fee for unit trusts, reducing the advantage of investment trusts. Also in the last few years and new breed of investment has arrived, called the Exchange Traded Fund (ETF). This is similar to a UT excepts its price is quoted continuously through the trading day, like an IT rather than just once for a UT and there is no real manager, because they simply track an index using computers, therefore have very low annual fee and small bid/offer spread. I use these for short term trading and ITs or other shares for longer term trading.
Unit Trust Books
Disadvantages of UTs/OEICs
UTs and OEICs spend a lot of promotion whereas Investment trusts rarely advertise, and therefore waste far less of your management fee than with UTs. They also do not pay commission to financial advisors, so, with the exception of truly independent advisors, who are not paid by commission, or who share their commission with the customer, they are unlikely to be recommended. The other reason ITs are often shunned by retail investors is that they are more complicated and can be riskier.
Most investment trusts trade at a discount to the value of the underlying investment (the net asset value, or NAV of the share will be higher than the share price) so you get more shares for your money and more dividend, but the discount still applies when you sell too. The discount generally shrinks during good times because there are usually a fixed number of shares, so the price goes up disproportionately with demand. This magnifies the market movements and makes them riskier during a downturn. Some very popular investment trusts may even trade at a premium during a bull market. When choosing an investment you need to take the discount into consideration, not just its absolute value, but also whether it is higher or lower than usual. This adds complication. It is important to monitor the variation of the NAV when comparing performance with other investment, because this is the measure of the underlying performance, rather than just the value.
Investment Trusts are allowed to borrow money to invest, which is a practice not allowed for unit trusts, thereby gearing-up the investment (that's English for "leverage")
Another complication of ITs over UTs is the different types of share available for some companies. Some investment trusts are split capital investment trusts which are covered in my other review "Almost crash-proof") and a misselling scandal a few years ago, specifically for the zero-dividend preference share variety of split caused all investment trusts to be tarred with the same brush, causing more mistrust. Conventional investment trust are different, and easier to understand that these more obscure investments.
Investment trusts are companies and therefore have to have an annual general meeting, to which you will be invited if you own shares, or you can vote using the postal vote form sent with the annual report. This, for me makes them more interesting, although I have not yet attended a meeting. UTs are not companies and do not have these meetings.
Unit Trust Charges and How to Avoid Them
As I stated before, UTs/OEICs generally have high charges to pay the outrageous commission to the advisors (hence their being recommended and ITs are not) A typical initial fee of 5% is charged, most of which goes to the advisor, then a management fee of perhaps 1.5% each year (although the real cost is higher and you should always try to find the Total Expense Ratio which includes the share trading costs and could be 2%, 2.5% or even higher) This may not sound too bad but lets put this in perspective:
You win Â£1,000,000 on the Premium Bonds or Lottery and visit your bank manager and he calls in an advisor who spends a couple of hours with you discussing how you want to live off this money. He recommends a selection of unit trusts and doesn't charge you a fee (what a nice chap); A safe Balanced Portfolio mixing stocks/shares UTs, bond UTs and Gold mining UTs which will hopefully beat inflation and pay you an income better than a bank account for ever. Wonderful. An income for life, growing with inflation or better.
This would result in the advisor getting Â£50,000 commission straight away (for a couple of hours work) then he gets perhaps Â£5,000 a year for life and the investment manager gets Â£15,000 per year for life. Over 30 years, if the investment manages to track inflation and pay you an income the advisor and the investment company will take Â£200,000 in fees (in today's money) The advisor may phone you up each year and advise you to change half of the UTs to a "better" fund and he will then get another "Â£25,000" a year in commission meaning a total fee of Â£925,000 (i.e. almost the same amount as you have left). What a brilliant scam.
If however you ask your "advisor" (i.e. salesman) to give back some of the commission you may actually get it, or alternatively go to a discount broker such as Hargreaves Lansdown, Selftrade, Interactive Investor" who will give back most of the commission and some of the other fees. Hargreaves Lansdown also gives their ISA customers a Loyalty Bonus that returns some of the annual fee (the part that would have gone to the salesman) e.g. 0.1% to 0.375% of the total invested. This may not sound like much but it really adds up and demonstrates quite how much of a rip-off the usual fees are.
Rich Dad Poor Dad
Alternatively Invest in Gold
There are some excellent unit trusts that invest in Gold and gold mining companies, such as Blackrock Gold and General, alternatively a direct holding of gold coins or gold bars makes a good addition to an investment portfolio.
Low-Cost Unit Trusts: Index Trackers
Fund Supermarkets and Low-cost Tracker Unit Trusts
As I pointed out above a lot of money is wasted on Unit Trusts because of excessive fees both to the advisor and to the fund-manager, but some of these fees can be avoided by buying with a fund supermarket or discount broker such as Hargreaves Lansdown, Selftrade, Interactive Investor". If you are only going to buy Unit Trusts, then Hargreaves Lansdown is one of the best around and really does give back all or most of the initial fee and some of the annual fee (the annual management fee of most unit trusts includes a commission to the salesman and Hargreaves Lansdown gives some of this back to the customer as a Loyalty Bonus) but how is Hargreaves Lansdown so profitable? They have a huge number of customers because they are one of the cheapest brokers around and the money that they are paid is still significant. Most of the unit trusts recommended by Hargreaves Lansdown in their "Mark Dampier's Wealth 150" list have fairly high fees even after some of the commission has been repaid to the customer, because they are recommending good managers who often don't come cheap. Many fund manager don't even beat the stock market index once the fees have been taken off, so why not just track the market?
How do you avoid high Unit Trust fees?
As explained before investment trusts (with lower management fees) and ETFs (most of which are index-trackers) with much lower charges could be the answer, if you have a large amount of money to invest, but these usually have a dealing cost per trade (e.g. typically about Â£10) and there might even be a quarterly or annual fee from you broker if you start dealing in these or other shares, so they may not make financial sense either, but some unit trusts actually have very low fees and are not widely recommended. Not generally as low as ETFs but not bad. e.g.
Legal and General has tracker unit trusts that track a variety of indices with Total Expense Ratios (TERs i.e. management fees plus all other costs) as low as 0.25% tracking bond markets, stock markets, FTSE. Fidelity also have a "Money Builder" tracker that tracks the FTSE All Share index. These will never beat the market, but you don't have to pay a manager because they are run by computers. In general, if you stray away from local markets these are still quite expensive. e.g. to track a UK index it may cost just 0.25% but L&G and Fidelity will charge 0.83% or more for some markets such as Pacific, Japan or European, whereas HSBC is one of the best tracker providers with fees as low as 0.37% even for European and Pacific and just 0.27% TER for Japan. Vanguard is a new arrival in the U.K. with some more very low-priced funds (although not yet available from some fund-supermarkets)
New Rules: Retail Distribution Review (RDR)
What is the Retail Distribution Review?
On 1st January 2013 the Financial Services Authority (FSA) introduced new rules which change the way financial advisors can operate. These new rules are known as the Retail Distribution Review (RDR) and should introduce greater clarity about types of service being provided and the charges.
What are the new RDR Rules?
Now, under RDR there are just two types of financial adviser: Independent or Restricted.
Independent Adviser: Required to research the whole market for products which might be suitable for their client, including more 'exotic' products, such as Investment Trusts, Exchange Traded Funds or Venture Capital Trusts
Restricted Adviser: Can consider a smaller range of investment products and product providers.
Both Independent and Restricted Advisors must be qualified to the same higher level benchmark: Chartered Insurance Institute Diploma level (or equivalent).
Charges: Before RDR there were several ways you could pay for advice: upfront (e.g. hourly) fees, or initial and ongoing "trail" commission paid by the investment company you chose to invest in (as described above). RDR requires all financial advisory firms to clearly set out the charges the client will pay before providing any advice and in order to make an ongoing charge (i.e. like the old trail commission), the adviser must provide an ongoing service.
If you already hold investments with an advisor you may find the old rules still apply and that trail commission is stall being deducted and there may be many types of unit available for the investments you hold, some that do deduct commission and some that are "clean", so it is worth being vigilant in this transitional period to make sure you really are getting the best deal.