Products Unit Trusts/OEICs
Choosing Unit Trusts needs as much care as choosing individual stocks

Unit Trusts are....?
Unit Trusts (and their more modern equivalents, Open-ended Investment Companies - OEICS, pronounced "oiks") are pooled investments, also called collective investments. The Trust comprises a pool of individual investments of a defined class (shares in large companies, for example).

When you buy "units" in the trust you buy a small slice of the pool. The value of your units is equal to the value of all the small slices of individual investments that your units represent. Investors' cash is used to buy more investments. Investors' sales ("redemptions") are satisfied by the sale of investments. This type of arrangment is called 'open-ended', and is the big difference from Investment Trusts, which are 'closed-ended'.

Unit trusts are a very practical and simple way of enabling a small investor to achieve the higher returns available from risky investments, while spreading that risk through diversification.

So what's the problem?

How should you pick one?
Any book of investment advice lists a number of things you must check out before investing in a unit trust. Here's one such list:

  • Balance with the rest of your portfolio
  • Avoid poor historical performance
  • Track the record of the fund manager
  • Look for consistency of performance
  • Analyse the fees
  • Look for a manager who invests in his own fund
  • Check the risk level
  • Check the manager's investment constraints
  • Look at the fund size
  • Check that the firm behind the fund is stable

Now this is good advice. It's also a process that we would find it hard enough to complete for ourselves. You, gentle readers, who have found something better to do with your lives than become investment anoraks, would find it quite impossible.

Why not pick one at random?
The trouble is that the average unit trust does not deliver.

Recent (2002) research shows that 82% of all actively-managed funds failed to beat the FTSE100 over the past 20 years. 'Actively-managed' means that the fund aims to apply superior skills to improve returns. Usually, the level of management fees reflects the high skill supposedly applied.

But this research showed that costs exceeded any superior returns obtained. In other words, excess trading gains went into the pockets of the managers and not into yours. Other research in both this country and the US has shown this is not an isolated result.

So you would be better off throwing darts at the FTSE100 list instead of picking a unit trust at random. Or, if you feel you need more diversification, buying a tracker.

How do you pick one?
So here's some better advice:

  • Talk to a proper adviser before you do anything.
  • Understand the importance of costs. Only buy funds that clearly state their total expense ratios (TERs), not just their management fees. (For a general fund this TER should be less than 0.75% with zero initial charges and zero exit fees). If a fund is ambiguous about its costs, what else is it trying to hide?
  • Ignore historical performance unless it has been processed by an independent analyst. Poor historical performance indicates a dog. Good historical performance proves nothing. See Pick On Performance?
  • If you take costs seriously you will only be buying trackers or other low-cost diversified funds
  • UTs can always put their charges up (did you realise that?). Look at the Trust's long-term reputation to reduce the risk of that happening to you.
  • Before buying a unit trust at all, consider whether you are getting enough extra diversification to compensate for the lower return you will achieve (because of costs) compared to direct investment in equities. Reconsider your attitude to risk.
  • Don't buy a fund with persuasive advertising. You are paying for all that clever marketing. If you doubt this, look at some of the pages in "Choosing Products". Particularly Hype.

Find good information on individual trusts at Trustnet.

How do you buy one?
Did you think you should just call them up? Wrong!

Extraordinarily, that's usually the most expensive way of doing it. The thing to watch is the initial charge. This will usually be 5% and you will certainly pay it if you buy direct. Find a broker that gives a discount or try a funds supermarket (which does what the name suggests). Fidelity Funds Network is the biggest.

A unit trust may be right for you. But also check out (through your adviser) the bright new kid on the block - Exchange Traded Funds (ETFs). And also Investment Trusts.



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