Unit trusts and Open Ended Investment Companies (OEICs) are two very popular forms of collective investment in the UK. At a glance, they both do the same thing – take deposit of individual contributions from investors and group them together under a single management team. However these two different types of funds have quite a few differences, which this article will expand upon.
An unit trust is structured as a ‘trust’ founded by a trust deed which will lay out particular rules that the managers will obey. A unit trust is run by a manager, who makes day-to-day investment decisions and handles the administration of the fund. There is also an independent trustee, which is usually a large bank or insurance company. The role of the trustee is to legally hold the unit trust assets and safeguard investors assets by ensuring the manager complies with the trust deed and acts fairly.
An OEIC is actually a Limited Company (Ltd) and is created by an ‘instrument of incorporation’. Assets are not held by a ‘trustee’ but by an independent depository, who fulfils a similar but narrower function. The company is run by a board of directors who will include the ‘Authorised Corporate Director’ (ACD) whom takes overall responsibility for investing the collective funds.
However the differences between OEICs and Unit Trusts are more distinct than the legal formation and governance structure.
The pricing method of a collective fund is important, because this will effect the how many units/shares you will get for your original investment, and how much cash you will receive when eventually selling them.
Unit trusts typically use a ‘dual pricing’ method, although in some cases they will adopt single pricing (see below). Under a dual basis, the manager will set two different prices; a higher buy price (AKA ‘offer price’) and a lower selling price (AKA ‘bid price’). Dual pricing means that you will instantly make a loss when investing in a unit trust, because if you bought units and wanted to instantly sell them back, you would only receive the lower price for your units. The ‘spread’ is the term given to the gap between the prices, and the wider this gap, the more expensive this initial cost is.
The spread incorporates any initial joining fee, as well as any transaction costs the fund will incur to buy underlying securities with your deposit. Where fund inflows and outflows are fairly equal, the unit trust will merely be transfering ownership of units from one investor to another, and will not have to buy or sell underlying assets, so the spread usually narrows in stable markets.
OEICs tend to use a ‘single pricing’ system, although the dual pricing option is available to them. The use of a single price doesn’t mean your transaction will be cost-free, as extra charges such as the initial fee will be billed to you separately instead.
Further distinctions between unit trusts and OEICs are small and will not affect the average UK investor. These include the ease with which OEICs can be marketed across Europe, whilst unit trusts are restricted to operating in the UK due to its reliance on UK trust law. The taxation differences between unit trusts and OEICs are identical as of writing, however as taxation laws change frequently, I advise you to do your research or consider whether you need a financial advisor.
Unit trusts and OEICs are often the solution for beginners wondering how to invest in shares. Because they use diversification, they can help reduce the riskiness of shares. However beware: OEICs and unit trusts can carry heavy intial fees (of up to 5%) and annual management fees (of up to 2%) which will eat away at your returns. These collective investments are usually actively managed, and form one side of the passive investment vs active investment debate.