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A Guide to Lump Sum investments


Unit Trusts, Investment trusts and OEICs

 

Unit Trusts

Unit Trusts are pooled investment vehicles. In other words relatively small sums from clients are pooled to form a large fund which is able to invest in a broad spread of stocks and shares and other assets. Investors’ interests are protected by the terms of a trust deed which must be approved by the Financial Services Authority before a unit trust is authorised to accept clients’ money. Because they invest in stocks and shares, unit trusts must be viewed as medium to long term investments. This means that they should be held for at least five years, preferably longer, in order that the investor can potentially benefit from capital growth and a rising income.

Unit trusts offer investors significant advantages. The fund can invest in a broad spread of stocks and shares which brings greater security than investments into single company shares. Each fund will benefit from the expertise of a professional fund manager who takes on the responsibility of the day to day investment decisions. Unit trusts offer a simple way of benefiting from an investment in the stock market. They avoid the complications and many of the risks associated with a person buying and selling individual stocks and shares.

Units can be easily bought and sold and the prices are published in the press. The price at which units can be purchased by individuals is called the offer price which is higher than the selling or bid price. The difference between the two is known as the bid-offer spread. The prices of units are determined by the value of the assets in the fund. As the asset value rises or falls so do the offer and bid prices of units. Income from assets owned by a unit trust is accumulated and regularly distributed to unit holders (normally twice a year). Alternatively income may be re-invested by purchasing more units. Income, whether distributed or re-invested, is liable to income tax.

When a dividend is distributed to a client the tax voucher issued will show the ‘deemed gross dividend’. The client will only receive 90% of this amount but, it is the deemed gross dividend that is assessed to determine whether any further income tax is due. The total tax paid will vary depending on income.

  • Basic rate tax payers - 10%.
  • Higher rate tax payers – 32.5%.
  • Additional rate tax payers – 42.5%.

If, when units are sold, their value is greater than when they were purchased the investor will have made a capital gain. This is potentially liable to Capital Gains Tax if it exceeds the investor’s exemptions and reliefs.

Investment Trusts

Investment trusts have been established since 1868 and are nowadays extremely well used methods of investment. Although branded ‘trusts’ they are not subject to a trust deed like unit trusts; however, they are a pooled investment. Investment trusts are limited companies and are governed by a memorandum of association just like any other limited company. Their company directors are usually fund managers or investment experts. Their profit is made for their shareholders by buying and selling financial instruments such as stocks and shares.

It is possible for shares in investment trusts to be ‘trading at a premium’ or ‘trading at a discount’ for example:

  • shares in issue = 1 million.
  • underlying asset values = £1 million.
  • therefore each share is worth = £1.

This £1 is open to fluctuation due to influences and market sentiment just like stocks and shares. Therefore if the shares are trading at £0.95p they would be trading at a discount. If they were trading at £1.05p they would be trading at a premium. Investment trusts are closed ended investments (unlike unit trusts which are open ended) and should they wish to acquire more investments than their share capital allows, they can benefit by ‘gearing’. This simply means that they can borrow money to invest. Therefore a ‘highly geared’ investment trust would have large borrowings and could be considered high risk, especially in a falling (bear) market place. All the tax implications for investment trusts are the same as shares as this is actually what the investor buys.

Open Ended Investment Companies (OEICs)

The rules concerning OEICs were given approval by the UK treasury in January 1997. An OEIC could be considered a hybrid between a unit trust and an investment trust company. The reason for their introduction into the UK is because they fall in line with their European counterparts and thus make the marketing of UK collective investments much easier and understandable both here and in Europe. They benefit by single pricing, rather than the UK’s traditional dual pricing (the bid offer spread). They have the same buying and selling price with initial, exit and annual management charges expressed separately.

A guide to their basic structure is:

  • They are recognised incorporated companies.
  • Like investment trusts, investors buy the company’s shares and benefit by the income and growth, or both, of the underlying shares they are trading in.
  • The trading price of OEIC shares are based on the underlying asset value like unit trusts.
  • Like unit trusts they are open ended investments that can expand and contract to meet consumer demand.

All the tax implications for OEICs are the same as shares, as this is actually what the investor owns.

NEXT STEPS

To learn about other investment options, return to the Introduction to investments section.

To learn about the following investments, if you aren't already familiar with them click on the relevant link:

However if you feel that you need some help from a financial advisor, then visit our section on obtaining financial advice, or our page on Laterlife selected services and associated advice.

 

   
 
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