By investing in collective investments ' usually a mixture of unit trusts, Oeics and investment trusts ' investors can reduce their exposure to risk, avoid paying capital gains tax and improve their investment timing
One answer to the problem of spreading risk, sheltering capital gains from tax when making switches and getting investment timing right is to invest in collective investment vehicles.
The most well known of these are unit trusts ' now often converted to open-ended investment companies or Oeics managed through an Authorised Corporate Director (ACD) ' and investment trusts. These three types of vehicle all have the advantages of being free from UK tax on capital gains made within the vehicles themselves, being run by professional managers and spreading risks by investing in a range of companies or stocks rather than just one. The essential differences between the structures is set out in the table.
Given that all these vehicles can offer stock market exposure and other advantages, what are the main differences between them and what, aside from investment performance, should advisers consider when recommending one or other structure to their clients? Again, the essential differences are set out in the table.
There are many similarities. Obviously, each vehicle will have a specific investment objective. There are vehicles of all types that offer general exposure to equity markets internationally, or specifically in, say, the UK or Japan. There are also vehicles of all types which aim to offer regular income or focus more on capital gain.
Despite the differences in structure, all will over time rise in value if the relevant markets rise, and fall if they fall, although exceptionally an investment trust's share price may move in the opposite direction in the shorter term because of its pricing structure.
Investment trusts are run by boards of directors who appoint the manager and regulate its terms of office. They act on behalf of the shareholders to oversee the actions taken by the manager. Unit trusts are regulated by a trust deed, with corporate trustees appointed to protect unitholders' interests.
Oeics, on the other hand, usually have no external directors and shareholders' interests are safeguarded by the depositary, usually a bank acting like the trustee of a unit trust, who ensures the ACD acts in accordance with the prospectus and the relevant regulations from the FSA.
Like unit trusts, Oeics are open-ended and anyone buying or selling shares can apply to the ACD and will deal at the net asset value of the underlying assets.
Investment trusts are companies and are quoted on the stock exchange.
They are closed ended, which means that the shares are fixed in number and will only change if the directors of the company decide, subject to shareholder approval, to issue some more, buy some back from existing holders and cancel them, or wind up the trust. Investors buy and sell these shares through a broker or a savings scheme (such as a share plan or Isa) at their market price.
The market price is usually different from the value of the underlying assets and when it is lower, this difference is referred to as the discount. When higher it is the premium.
A discount (which generally prevails) can be an advantage to investors, since they are buying, say, £1 worth of assets at, say, 85p. Clearly the discount can change over time and the return from investment trusts may thus reflect more (or less) than the return on the underlying securities.
Generally, the directors of the trusts will seek to take action to increase the net asset value per share (for example by buying shares back). Such action may help to reduce the discount over time. Details of the discount prevailing are available in the national press share price services.
One feature of an Oeic or unit trust being open-ended is that the size of the fund will grow or diminish depending on the demand for its shares, although this of course has no impact on the share price. This has implications for the management of such funds in that they have to be managed so as to enable assets to be realised as required to meet selling pressure.
As investment trusts are quoted vehicles, an investor buys or sells shares at the price quoted on the stock market. The share price may at times be higher than the value of the underlying investments held by the trust (premium) or the net asset value of the holdings may be worth more than the share price (discount). This premium or discount can widen or narrow depending on market sentiment and so the value of an investor's shares is not solely dependent on the skill of the investment trust's manager.
This factor offers attractions to many investors, but those who want the assurance of price, which reflects their investment's net asset value, should opt for an Oeic or unit trust. One further advantage of investment trusts is that, being listed companies, they can borrow strategically in the long term, as well as tactically in the short, term. This gearing should enable trusts to create added value when equity markets are rising by comparison with Oeics, which cannot borrow so freely.
So if you believe equity markets will rise, an investment trust with gearing (some have more than others) will offer the prospect of higher gains. The opposite effect occurs in falling markets, where a highly geared investment trust can fall in value disproportionately more than a fund without gearing.
Investors should therefore make sure they understand the nature of the investment they are making and the risks they are taking. Some investment markets are more risky than others and some structures are inherently more risky.
Another important factor is the cost of investment management and administration. Many Oeics and unit trusts have annual management fees of over 1.25% or more per year.
Investment trusts are often larger, although this is not universal and their fees are often quite low ' 0.5% per year or even less in large, general trusts, for example. The lower investment trust fees reflect the efficiency of managing large, stable funds. They also reflect the fact that the manager of an Oeic or unit trust will normally pay various costs such as marketing, printing, price publication etc. out of its fee, whilst at least some of such costs are charged to the investment trust itself.
These added costs of custody are however a smaller proportion of the asset value in large investment trusts than in smaller funds. So investment trusts can be good for long-term investors as the fees and costs are generally low, long-term investment views can be taken, and the possibility of gearing and the added hidden value, if a discount prevails on purchase, should enhance the long-term prospects.
Finally, the Oeics and unit trusts are generally priced so buyers pay an up-front charge of perhaps 1%-5%. This pays for commission to intermediaries and offsets the cost of the manager's administration.
For investment trusts, the only up-front cost is usually stamp duty and broker's commission on share transactions, but this is usually lower in total, especially for investment through share plans and Isas where the costs are usually often subsidised by the existing shareholders of the investment trust.
For intermediaries, many investment trusts can be purchased through the managers via share plans or Isas which offer very low brokerage charges, and the facility to pay commissions out of the investor's subscription. So intermediaries can be paid for their advice using all these vehicles ' it is up to them to agree the most appropriate method with their clients.
There are some differences between Oeics and unit trusts. The main ones are that Oeics have been launched under regulations that require single pricing, whereas, until recently, unit trusts were all required to use dual prices. This supposed simplicity may be confused however by the right of the ACD to charge, on behalf of the fund, dilution levies to cover the cost of dealing in the underlying securities.
Not all ACDs will levy such charges, and if they do not, the fund will be diluted by the cost of securities transactions it makes as a result of creations and liquidations. The second main advantage of Oeics is the ability for managers to second, Oeics may also offer different share classes in the same fund, for different categories of investor. These generally only differ in the amount of the initial and/or management fee.
For example, retail shares might bear a 1.25% management fee, whereas large holders (say, investments of over £250,000 or £500,000) might bear fees of 0.5%-0.75%pa. The higher retail fees allow the possibility of splitting the fee between the ACD and the intermediary, while the lower fee classes may be used for fee based intermediaries or multi managers.
For the long-term saver, unit trusts, Oeics and investment trusts all offer the possibility of stock market investment in most of the markets of the world. Investment trusts have greater flexibility to gear, and so potentially reap greater rewards from rising markets; they often have lower overall costs of administration. Both can be suitable for first time equity investors, since both will bear the risks and get the rewards of stock market investment.
differences between unit trusts/oeics and investment trusts
Investment Trust Daily stock exchange prices available at bid and offer through a broker; broker's commission and 0.5% stamp duty may be an added expense. The bid/offer spread is typically 1%-2%. The price depends on supply and demand for shares and is thus not defined as equal to the underlying net asset value.
Oeic Single (mid) priced daily by the ACD at underlying net asset value. May be subject to a dilution levy to protect the interests of the existing investors in the fund by paying forset to represent the costs including stamp duty of buying and or selling underlying securities. There may be initial charges. Total spread including charges and commissions might be 5%-7%.
Unit Trust Usually dual priced daily at underlying net asset value by the Manager, reflecting the cost including stamp duty of buying securities in the creation price and the cost of selling securities in the cancellation price. There may be initial charges. Total bid/offer spread including charges and commissions might be 5%-7%.
Remuneration of intermediary
Investment Trust Fees charged directly to client, or commission & brokerage deducted from sum invested, or met from charges in wrapper wrap products plus brokerage if a stock broker.
Oeic Fees charged directly to client or commission paid out of manager's charges.
Unit trust Fees charged directly to client or commission paid out of manager's charges.
Investment trust Closed ended, so fixed in size, expanding and contracting only at the directors' option, subject to shareholder approval.
Oeic Open ended, so expanding and contracting depending on the demand for shares.
UK Open ended, so expanding and contracting depending on the demand for units.
Regulation Governed by the Companies Act and the listing rules of the stock and supervision and supervision exchange, as well as subject to Inland Revenue approval. Under the supervision of the directors.
Authorised by the FSA, managed by the Authorised Corporate Director, and under the supervision of the Depositary who holds the assets.
Authorised by the FSA, managed by the Manager, and under the supervision of the Trustee who holds the assets.
Borrowing powers Governed by the Memorandum and Articles of Association but unlimited in theory and are often long term.
Restricted to a maximum of 10% of the value of the fund on a temporary basis.
Share and unit types. Ordinary shares are most common. Split capital trusts have more than one type of share which have different rights set out in the articles of association.
Different share classes are possible, generally reflecting different fee levels. These permit eg lower fees for large investments. Accumulation and income shares are possible.
Units are all equal but accumulation and income units are possible.
Source: Baillie Gifford
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