Compare The Platform: Types of funds

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  • Types of funds

Types of funds

Generally speaking, if you want to invest long term either in a Sipp, an ISA or direct, the easiest way to do so is through a fund.  These are products where investors’ money is pooled together to create a portfolio that is invested in a range of assets, such as UK shares, overseas stock markets, corporate bonds or commercial property,

The advantage of investing through these funds is that for a modest sum of, say, £500 or even less you can gain exposure to a large number of investments which means that your risk is spread.  A fund will only invest a small portion of its portfolio in any one company so if the company goes bust the effect on its value is minimal.  By contrast, if you invest in a company’s shares direct and it goes bust you could lose the whole of your investment.

Another advantage of funds is that they are run by professional managers.  There are two distinct styles of management:

  1. Active – the managers of these funds will research the market and try to pick the best investments to match their funds’ objectives and avoid those they think will fall in value.
  2. Passive – the managers of these funds will try to match the performance of a particular stock market indices as closely as possible.

There are three main types of funds to choose from: investment funds (also described as unit trusts, mutual funds, open-ended investment companies (OEICS) and other abbreviations), investment trusts or companies, and exchange-traded funds, usually referred to as ETFs.

Investment funds

These funds are the most popular investment product in the UK nowadays. There is over 2,500 funds available run by many different investment companies. They are divided into around 30 different sectors to reflect their different investment objectives.  Some focus on UK shares, others on US, European or Asian markets, or they invest globally. Some focus on certain types of corporate bonds or invest across a range of different bonds.  There are also funds that invest in commercial property.

Some funds aim to generate income, while others look to produce capital growth. Some hold a mixture of investments in order to achieve balanced returns and reduce price fluctuations. Some funds aim to produce positive returns in all investment conditions.

Investors are allocated a certain number of shares or units in these funds by the company which manages them and the price of these shares will rise and fall in line with the value of the fund’s underlying investments. Funds expand or contract in size depending on how popular they are with investors. Companies will issue or redeem shares/units in the funds as necessary and buying more investments as they grow and selling them when investors want to withdraw their cash.

Ongoing annual charges are deducted from the funds to cover the cost of investment management and administration. These are typically around 0.5% per annum for actively managed funds. Passive funds are lower cost because they involve less management time.

Investment trusts

The first investment trusts were set up in the UK over 100 years ago. There are over 300 available. Like investment funds, they are divided into different sectors and invest in many of the same areas. However, there are also more specialist investment trusts such as those which invest in private equity, or in areas such as renewable energy, forestry and peer to peer lending.

Investment trusts are structured differently to investment funds. They are formed in the same way as companies with a fixed number of shares. For this reason, they are also described as closed-end funds.  They are traded on the stock market and the price of the shares is determined by demand and supply from investors as well as being influenced by the value of the company’s investments.

This means an investment trust’s share price is rarely exactly the same as the value of its investments, which is referred to as its net asset value per share. If the trust is in strong demand its share price may be higher than its net asset value, which means it is trading at a premium. When there is not so much demand, the price may fall to a discount.

It is normally not advisable to buy trusts when they are trading at a premium because you are paying over the odds. Buying trusts at a discount can be beneficial because you will gain a higher return if the discount narrows.  However, you have to be sure that the discount is not due to poor management.

The closed end nature of investment trusts can benefit their performance over the long term, especially if they invest in more specialist or illiquid areas. It means that they will not be forced to sell their best holdings if investors no longer want to own their shares, and they will not need to buy new investments when prices are at their highest if they become very popular.

Another difference between investment trusts and investment funds is that trusts can borrow money to invest. This is known as gearing. When investment markets are rising, this can enhance the returns on trusts, but when they fall it can increase their losses. The ongoing charges for investment trusts are similar to investment funds, though some of the more specialist trusts are more expensive.

Exchange-traded fund (ETF)

ETFs are funds that are traded on stock markets like shares. Most ETFs track an index such as the FTSE All-Share Index.  Besides share indices, there are also ETFs which track indices of bond prices and commodity prices and other assets such as foreign currencies. Normally ETFs own the same shares or whatever other assets make up particular indices in order to replicate their price movements.

The ongoing charges on ETFs are low because they are passively managed. However, investors will have to pay stockbrokers’ dealing charges when buying and selling them. Passive investment funds can be cheaper nowadays.

iShares and Vanguard are the two leading providers of ETFs.

2019-04-26T16:19:57+01:00

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