OEICs are often touted as the ideal solution for people new to investing. But what exactly is an OEIC and is it the right option for you?
What is an OEIC?
An OEIC (Open Ended Investment Company) is a form of shared investment fund, used to buy shares on the stockmarket with the intention of growing its investors’ money.
OEICs are described as shared investments because your money is pooled together with other investors’ to buy and sell shares in a wide range of companies, generally within a particular market.
This gives the fund more buying power to make larger and more diverse investments than the individual investors would be able to manage on their own. While this is good from a growth-perspective it also helps to reduce the risk to your money.
The market a fund operates in can be defined geographically, by asset type, or by sector type and this will dictate the types of underlying investment that are made. The level of risk will also vary from OEIC to OEIC depending on the manager and the aims of the fund (income or growth for example).
OEICs are “Open Ended” because investors like you can buy or sell shares in the fund whenever they want and without notice, and the size of the fund will grow or shrink to mirror this.
The main difference between OEICs and Unit Trusts is that the buy and sell price of OEIC shares are identical. So if you decide to sell your shares, you don’t need to wait for their value to climb before you can get back what you originally paid.
How do OEICs work?
When you invest in an OEIC you’re effectively buying shares in the fund. The amount you’ll pay per share is known as the ‘offer price’, this is generally the same as the ‘bid price’, the amount you would get if you sold your shares.
The shares you buy are created on the spot so that the size of the fund directly reflects the new investment. Your money, along with other investors’, is then used to invest in a broad selection of stocks, shares and other assets, which are together known as its portfolio.
There is a difference between the size of an OEIC fund, and its value. The size of the fund is tied to the number of shares issued, whereas the value of a fund is linked to the performance of its portfolio.
This means that if the value of an OEIC’s portfolio increases, the value of its investors’ shares grows proportionally to represent this, the same applies if the value goes down.
This risk is something that you’ll need to be comfortable with as there’s no guarantee as to the returns available and the value of your initial investment could decrease as well as increase. You can reduce the risk to both your capital and profit through the investments and the OEIC you choose.
What are the benefits of OEICs?
OEICs group your money together with other investors’, so they can invest in a wider range of shares than you would be able to individually. This spreads the risk to your money, as the impact of a single stock performing badly will be softened by shares in other companies.
Similarly, OEICs are managed by investment experts so by investing through them you can take advantage of their experience and knowledge.
Some OEICs have separate sub funds, each specialising in a different market. This can help to spread a fund’s risk by owning a wider investment portfolio.
What are the risks?
Although OEICs attempt to manage risk by investing in a diverse portfolio and calling on the experience of professional fund managers, there is the chance that your investment could devalue.
If you invest monthly via direct debit, this can mean you get more shares for your money and, if the OEIC shares’ value recovers, this could work in your favour. However, as with all investments there is the chance that you may lose more than you invest.
How do OEICs pay investors?
OEICs pay investors distributions, which are the dividend payments from the fund’s portfolio. Your distributions can be paid monthly, quarterly or every six months, depending on the OEIC.
Distributions can be paid as cash, in which case they are usually credited directly into an account in your name. Alternatively, you can choose to have them automatically reinvested in new shares in the OEIC.
At the same time, if the OEIC’s fund rises in value you may be able to sell your shares in the fund for more than you paid for them. However, transaction costs such as administration and taxes may apply.
Taxation of OEICs
It is possible to invest in OEICs tax free through an Investment ISA so that your profits aren’t subject to Capital Gains or Income Tax. You can invest up to £11,280 through an Investment ISA this tax year (less anything you pay into a Cash ISA).
If you don’t invest in an OEIC via an Investment ISA, distributions are subject to Income Tax (the rate depends on your income from other sources) while profit on selling your shares in a fund is subject to Capital Gains Tax.
OEIC regulations
Each OEIC has a board called the Depository whose job is to ensure that the fund manager adheres to company policy and government legislation.
OEICs are also regulated by the Financial Conduct Authority (FCA), so they must adhere to certain standards and have procedures for dealing with investors’ complaints. This also means that services such as the Financial Ombudsman are available to investors if problems arise.
OEICs are not directly covered by the Financial Services Compensation Scheme – but their parent company will be. The maximum claim via the FSCS is £50,000 per person, per company. (Note that this isn’t cover for if your shares lose value.)
The cost of OEIC investments
There are three costs involved with investing in OEICs, these are the share price, initial fee and an Annual Management Charge (AMC).
OEIC share prices are updated daily, so online OEIC prices should reflect the current price per share. The price is the same whether you’re buying or selling shares in the fund.
- Initial fees are charged when you purchase shares in an OEIC. Typically these will be around 5% of your investment although this changes per fund.
- Actively managed funds usually charge around 1.5% as an Annual Management Charge, although this can change after administration and legal fees have been added. These are often lumped together as the fund’s Total Expense Ratio (TER). Tracker funds don’t require the same level of management, so often prove cheaper than actively managed funds.
In order to find the best OEIC fund, you should consider the market it operates in, its performance, the underlying investments, who the fund manager is and how it pays distributions to its investors.
When you have decided where your priorities lie, you can compare OEIC funds based on share price and the arrangement and management fees they charge.
