PAM Guide to Wealth Management

Collective Investments

Collective investments

Collective investments enable you to gain diversification across stocks and asset classes without having to buy individual securities. For low initial investments, you can gain access to professional investment managers. This does mean, however, that by buying units you share the collective investments with other investors.

While rare, it is possible for an open ended fund's performance to be negatively impacted if there are large redemptions by other investors and funds are forced to liquidate positions at a loss. This issue is a greater potential problem for small cap funds and those with less liquid underlying markets.

There are two main types of collective investments - open ended and closed ended funds. In the UK, these are known as unit trusts or OEICs and investment trusts respectively.

Unit trusts

A unit trust is divided into equal portions called units. As a unit trust is an open ended fund, there is no fixed number of units. Supply and demand, therefore, does not affect the price of the units and it simply determines the size of the unit trust. Prices of units directly reflect the value of the shares and bonds in a unit trust's underlying portfolio.

The Undertakings for Collective Investment in Transferable Securities Directive or UCITs is a pan-European decree designed to standardise collective investments across Europe. It acts as a passporting scheme, allowing unit trusts to be sold in any European Union (EU) member state, once they are authorised by any individual member state's regulators.

To complement UCITS, Non-UCITs Retail Schemes (NURs) funds were introduced. Up to 20 percent of these vehicles can be invested in non-regulated funds, including hedge funds. They can also invest in property funds, investment trusts and exchange traded funds. However, they cannot be sold across the EU.

Investment trusts

Investment trusts are publicly quoted vehicles and, like shares, are bought and sold through the London Stock Exchange. As investment trusts are closed ended funds, the amount of capital in issue is determined when the trust is established and there are a fixed number of shares. Further share issues can be offered in the future.

When an investor sells shares in the investment trust, the transaction takes place on the open market and the fund's manager does not have to sell any of the trust's holdings to meet redemptions. Investment trusts can borrow money to enhance their exposure to specific holdings, which is known as gearing, and most have a fixed lifetime, although they can extend their tenure with the approval of the shareholders.

The price of the investment trust's shares is driven by investor demand. As a result, the trust's share price does not directly reflect the net asset value (NAV) of the portfolio. The share price is often below the NAV per share, which is known as a discount. Sometimes trusts will trade at a premium if there is very strong demand, thought this is quite rare.

This can work for or against investors. If you believe a trust's returns will rise and demand will grow then you can benefit from both the NAV and share price rising. The reverse is also true, however.

There is also a tax benefit of collective investments. Switches between shares within collective investments are free of CGT, which is not the case if you manage a portfolio of shares yourself, unless these are held in tax efficient wrappers such as Individual Savings Accounts (ISAs).

Generally, asset managers launch umbrella funds that comprise their own sub-funds. In theory, it is cheaper to switch between sub-funds managed by one asset manager that invest in different sectors, or stock markets. Switches may trigger CGT charges, however.

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