Discover all you need to know about unit trusts and open-ended investment companies, with tips on picking investment funds
What is an investment fund?
Investment funds (known as mutual funds in the US) are collective investment schemes, which pool your money with that of other investors to give you a stake in a ready-made portfolio.
Two of the most popular types of fund are unit trusts and open-ended investment companies (OEICs). Exchange traded funds are growing in popularity and are covered in our separate guide.
There are several advantages to investing through a fund, from avoiding having to pick individual shares through to affordably building a diverse portfolio, as our video explains:
What are unit trusts?
With a unit trust, a fund manager buys bonds or shares in companies on the stock market on behalf of the fund.
The fund is split into units, and this is what you’ll buy. The fund manager creates units for new investors and cancels units for those selling out of the fund. The creation of units can be unlimited, hence why the fund is ‘open-ended.’
The price of each unit depends on the net asset value (NAV) of the fund’s underlying investments and is priced once per day. This means that the value of the units you buy directly reflects the underlying value of the investment.
- Find out more: the best investment platforms
What are open-ended investment companies?
OEICs operate in a similar way to unit trusts except that the fund is actually run as a company.
It therefore creates and cancels shares rather than units when investors come in and go out of the fund, but they still directly reflect the value of the assets that your fund manager has invested in.
It’s also possible to get closed-ended investment funds, more commonly known as investment trusts.
What is active and passive management?
If you’re placing your money into an investment fund, there are two main strategies you’ll encounter:
|Active management||Passive management (Tracker Funds)|
|Professional fund managers select which companies to invest in||Track an investment index|
|Aim to outperform the market||Aim to replicate the market|
|Generally higher costs||Generally lower costs|
|Can quickly pick and drop companies||Must wait until the index is reconstituted to pick or drop companies outside it|
An actively managed fund can offer you the potential for much higher returns than a market provides (or more protection from a falling market) if your fund manager makes the right calls.
There is no guarantee that they will do so, however, and in many cases passively managed funds will outperform actively managed funds.
Actively managed funds also tend to have significantly higher costs, which will impact on your investment returns (see below).
Actively managed funds may hold particular appeal for ethical or environmentally-minded investors, as managers can quickly end investments in firms involved in controversies.
Passively-managed funds may need to wait for the index they follow to be reconstituted – though in some cases this can be relatively frequent.
- Find out more: tracker funds explained
How do unit trusts and OEICs pay returns?
Returns from funds are typically paid through distributions. These can be monthly, quarterly or every six months, depending on the type of fund that you invest in.
These distributions derive from the dividend payments received by the fund from the underlying shares within which they invest, or interest payments from bonds or even rental income in the case of property.
Most unit trusts and OEICs will give you two options to choose from for payment.
- Income units – which pay the distributions as income or;
- Accumulation – where units wrap up those distributions and reinvest them in the fund, to increase the capital value of your investment.
While it’s possible to switch from accumulation to income funds and vice versa, this technically involves buying and selling funds and could trigger capital gains tax, unless your investments are held in an Isa.
Where can unit trusts and OEICs invest?
There are more than 2,000 different unit trusts and OEICs available to investors in the UK, investing in more than 30 sectors.
You can categorise how funds invest using various measures:
What the fund invests in; many will invest in equities (company shares); others in bonds; others in commodities. Asset classes play a big role in determining the risk and volatility of a portfolio.
Funds investing in equities may invest in a wide range of companies, such as the whole of the FTSE 100.
Or it could invest in certain sectors, such as technology and telecoms.
This matters as some sectors will be benefit and others will be hit by certain events, such as the COVID-19 pandemic, which benefitted some technology companies and hit airlines.
Different countries have different economies and hence very different levels of risk for potential investors.
Europe, the US and Canada, Japan, Australia and New Zealand are generally regarded as developed markets; other countries as emerging markets with higher risks and potential for reward.
As well as active vs passive, this also encompasses other divides.
Growth vs income, for instance, is about whether you want your capital to grow, or want to receive a regular income in the form of dividends.
Growth vs value is about which companies you invest in. Growth companies are firms that are growing quickly; value companies are historically strong firms that are seen as undervalued.
There are funds that invest in other funds, called multi-manager or fund of funds.
Rather than investing directly into individual assets, these funds invest in other collective investments, with the expectation that specialist managers in the various asset classes will produce top performance.
Multi-manager funds can be a good option for beginner investors, as they remove a huge amount of time spent researching. Some multi-manager funds are tailored to particular risk appetites.
- Find out more: how to build an investment portfolio
How much do unit trusts and OEICs cost?
Most fund groups have now all but given up on initial charges and ongoing charges have typically reduced by half over recent years.
An annual fund management charge of 0.75% the new norm for actively managed funds, rising to around 0.85% when the additional expenses are added to make up the full ongoing charge figure (OCF) which replaces the old TER.
Tracker funds remain much cheaper in most cases, with some index funds now charging less than 0.1% in ongoing charges.
Although small, costs have been found to be the biggest drag on performance in investment funds. But the charges are mandatory, even if your manager has returned less than the market or, worse still, lost you money.
- Find out more: fund charges explained
Where can you buy unit trusts and OEICs?
Investment platforms also enable you to invest through a stocks and shares Isa, Junior Isa or Lifetime Isa, shielding you from tax and, in the case of the Lifetime Isa, providing extra benefit.
We’ve surveyed over a thousand customers and analysed platform costs to pick our Which? Recommended Providers.