Unit Trusts & OEICs: An Ideal Solution for Cautious Investors?

If you are looking to invest for the first time & want to be able to manage risk to your capital, then a unit trust or an OEIC may be an ideal solution. Here is everything you need to know before you start.

The industry jargon of investment markets can easily seem daunting if you're new to investing.

Unit Trusts and Open Ended Investment Companies (OEICs) sound complicated, but if you are thinking of investing your hard earned cash for the long term then they could be the best place to start.

Here’s what you need to know about investing in unit trusts and OEICs, without the jargon!

What is a unit trust?

A unit trust is an open-ended grouped investment. This means unit price always represents the number of units, multiplied by value. Demand for units has no impact on price as they are created upon request.

When you invest your money is pooled along with other investors’ into a single pot called a fund.

The trust’s fund is then used to buy shares in a wide selection of companies as chosen by the fund manager, known as a trust’s portfolio. A unit trust’s portfolio will be in a single market or area (the trust’s investment objective).

Investors can buy and sell units at any point, which changes the size of the investment portfolio accordingly. The latest unit trust prices all distinguish between an ‘offer price’ and a ‘bid price’ – respectively, how much you can buy or sell units for.

Unit trust daily prices vary, but bid price is always fixed lower than the offer price at any given time. This rule means you have to wait for the bid price to climb above your original offer price before you would see a profit when selling, a cost to investors which OEICs don’t have.

What is an OEIC?

OEIC stands for Open Ended Investment Company. OEICs are very similar to unit trusts but with a few differences:

OEICs are incorporated as public limited companies (PLCs), meaning they can repurchase their own shares when investors decide to sell.

Second, OEICs prices are the same for both buyers and sellers: there is no difference between offer and bid prices. If you get cold feet, you should be able to sell shares back immediately for the same price.

In recent years many unit trusts have been changing to OEICs, largely because they are less costly to manage and offer greater flexibility.

Sub-funds can operate independently within a single OEIC, each specialising in their own market. This means OEICs can invest in more markets and hedge against bad performance in individual areas.

What are the benefits of OEICs and Unit Trusts?

The major benefit of both types of investment (unit trusts and OEICs) is that they allow you to diversify where your money is held.

Ordinarily it wouldn’t be cost effective to spread your money across shares in hundreds of different companies. However, a unit trust or OEIC makes this possible by pooling investors’ money into one large fund and using the total to buy a wide range of shares.

This means you should have greater opportunity for profit, and your risk should be spread thinner (shared between all investors).

Is your capital at risk?

As with all investments, putting your money into a unit trust or OEIC isn’t entirely risk free and investments can fall in value.

However, there are a number of factors which limit the risk you’re exposed to and make unit trusts and OEICs ideal for first time or risk adverse investors.

Firstly, your money is part of a larger fund that allows the fund manager to invest in a wide selection of different companies. If one of the chosen companies performs badly this loss is balanced by shares held elsewhere in the portfolio.

Secondly, you can also control the level of risk you are exposed to through the type of Unit Trust you select. Funds that primarily invest in large, well established companies in the UK and Europe generally represent a smaller risk than newer ventures – although this is by no means guaranteed.

Finally the way you invest can also influence your exposure to risk. Paying in on a monthly basis will mean that if the value of the unit trust or OEIC drops your next monthly instalment will simply buy more units. Assuming the fund recovers, any initial drop in value will be offset by the cheaper price you’ve paid for your units during the drop.

However, while this would cushion the impact of a fall in share values, investing in this way would also hold you back should your fund’s value soar, as your money would be buying you fewer units each month.

Who are unit trusts & OEICs most suitable for?

If you are looking to invest for the mid to long term and are happy to have little active management of your investments then a unit trust or an OEIC may be a good choice.

They are also ideal for anyone looking to invest a monthly sum who wants to slowly build up an investment portfolio.

Although any investment can go down as well as up in value, over a longer time period the best performing unit trusts and OEICs should outperform even the best saving accounts.

How to choose a Unit Trust manager

The unit trust fund manager is the person who decides where your money will be invested and who ultimately makes the decisions that will determine the success of your investment.

A good fund manager is vital to the best unit trusts. Before you invest in any trust make sure to check the manager’s track record independently of comparing current unit trust performance.

You should be able to easily check a fund manager’s track record online, most have their own website, to find out how they have performed in previous years. Nevertheless, that may not always be a good indicator of future performance.

Perhaps a better way to analyse a fund manager is to compare their performance to others trading in the same sector, this way if their results have been boosted by a buoyant sector but fail to match their competitors they may not be as good as their results suggest.

Equally if they are operating in a struggling sector but returned a profit while other funds incurred a loss – this will show their true quality.

How to choose funds

Each OEIC is likely to have several different funds which you can choose to invest in. Unit trusts on the other hand will operate in a single market. Funds can be targeted in a number of ways, including:

• Asset class (equity, fixed interest etc)

• Geographically (e.g. UK only, Europe only, US only)
• Exposure to risk (established companies vs. small or new companies/emerging markets)
• Market or sector type (for example renewable or ethical investments)

You need to look at your options, decide how you want to tailor your investments and then find a unit trust that matches your requirements.

You can use our unit trust comparison table to search the options available and to order unit trusts based upon their return over the previous 1-10 years to see how they have performed in the past.

For more information on how to choose a fund that meets your needs read our guide, 9 Steps to Finding an Investment Fund That Will Maximise Your Profit.

How to invest in an OEIC or unit trust

Most unit trusts will allow you to invest monthly via direct debit or standing order, or by depositing a lump sum.

Most funds will have minimum investment criteria, usually around £500 for a lump sum or £25-£50 if you want to invest on a monthly basis. The number of units you get for your money is dependent on the latest unit trust prices and OEICs prices.

You can also invest in certain unit trusts or OEICs through your annual ISA allowance to avoid paying tax on your investments.

Fees and charges

Investing in a unit trust or OEIC does come at a price. Most funds are actively managed by the fund manager, meaning the manager constantly reviews the fund’s investment portfolio. To pay for this they charge a fee of around 5% on initial deposits and then an annual administration fee of 1-1.5% each year.

It is possible to reduce the initial investment charge or possibly avoid it altogether by investing through a fund supermarket or an execution only broker.

However, these routes are cheaper because they offer no financial advice regarding your investment choices. They should only be used if you are confident in investing without guidance.

Can you change your investment?

If you decide after you have invested that you want to change funds or investment managers then you are likely to incur charges.

In most cases you will have to pay a transfer fee when changing funds, but if you feel that your money is sat in a sinking ship, it may be worth paying the fee to move it to a better home.