Investing Basics: What is a Unit Trust?

Unit Trusts are collective investments, actively managed by an investment  professional who seeks to deliver market-beating performance based upon the quality of their investment decisions; they can be used by the DIY investor to cost effectively build a diversified portfolio of investments – writes Christian Leeming

A fund may have investments in 50 or even 100 different companies in its portfolio, allowing you to obtain exposure to multiple stocks or bonds more simply than investing directly in the market yourself.

Unit trusts provide access to a wide range of geographic markets, different asset classes in a range of industry sectors that can be bought and sold via most investment platforms.

The funds generally invest in one or more of the main asset classes – shares, bonds, property, cash and derivatives and deliver a ready made investment portfolio that is inherently diverse.

Unit trusts are classed as ‘open-ended’ investments, as the number of units in circulation rises and falls according to demand.

The fund is run by a manager who uses the money that is invested to buy shares, bonds or other assets and divides the fund up into units; by actively managing the fund the manager seeks to out-perform the market by their investment decisions.

Additional units are created when new investors arrive and ones redeemed by those selling out are cancelled.

Once a day the value of all the assets within the fund are calculated to decide the net asset value (NAV) of the fund and the price of each unit is simply the NAV divided by the number of units in existence; the value of the units you buy directly reflects the underlying value of the investment.

Investors in a unit trust are ‘unit holder’ as opposed to those that choose Open Ended Investment Companies which are run as companies and therefore issue shares to their ‘shareholders’.

Unit trusts have bid and offer prices and therefore a spread, whereas OEICs have a single price and simpler pricing structure.

Identifying the Fund you Want

Unit trusts are usually designed to either deliver ‘income’ or ‘growth’ and there are often two different versions of the same fund; their name may be the same – FTSE All Share – but will often end in ‘Acc’ or ‘Inc’ depending upon whether it pays out regular cash dividends (FTSE All Share Inc = income) or whether it automatically reinvests the dividends it generates to buy more units of the fund (FTSE All Share Acc = accumulation).

‘Unit trusts are usually designed to either deliver ‘income’ or ‘growth’’

In the past funds incentivised advisers and platforms to sell their products and it was very difficult for the investor to know just how much was being paid to the adviser for the ‘free’ advice they dispensed; a fear was that an adviser could recommend a product on which they were paid a higher commission rather than the ideal one for their client.

The government’s 2012 Retail Distribution Review changed all that, banning commissions and forcing advisers to charge an explicit fee for their services.

However, that means that whilst new business will be written under the new rules – with ‘clean’ funds sold free of commission – legacy business remains where the vendor or adviser received an incentive payment.

Thus, funds may include an additional description although, unfortunately, there is no industry standard.

Generally, the addition of ‘R’ indicates a retail fund is aimed at personal investors whereas ‘I’ or ‘inst’ stands for institutional meaning that the fund is aimed at corporate investors like pension funds.

‘D’, ‘Y’, and ‘B’ are among the letters that show the fund is ‘clean’ and doesn’t use trail commission to incentivise financial advisers to push certain products.

This is certainly something the DIY investor should spend a little time getting to grips with.

Most funds are subject to the Undertakings for Collective Investment in Transferable Securities or ‘UCITS’ rules, set out under European Union legislation which includes a requirement to provide new investors with a Key Investor Information Document (KIID).

KIIDs allow investors to see all salient information about the unit trust including its key investments, its overall strategy and its charges.

UCITS allows EU-based funds to be marketed throughout the Union and delivers some protection to investors.

Types of Unit Trust

A number of broad categories of unit trusts are available:

• Equity funds invest in a range of shares which means they can be good for income if these companies pay a dividend; they can also deliver capital growth if the companies do well and their share price rises.
• Equity income funds aim to target companies that have historically paid strong dividends, or have the potential to increase their payouts.
• Multi-asset funds invest in a range of equities, bonds, commodities, FX and property and target countries or sectors requiring expert knowledge.
• Absolute return funds aim to produce a positive return irrespective of prevailing market conditions.
• Special situations funds seek to find apparently cheap shares where the fund manager believes there is the potential to unlock hidden value.

A combination of the capital growth and income generated by a unit trust’s underlying investments make up the return it delivers.

Funds are run by investment professionals who set out the objective of the fund and then make investment decisions in its pursuit.

The performance of the fund is intrinsically linked to the success or otherwise of the fund manager and past performance can give a very strong indication of what the future may hold.

‘Some, like Neil Woodford in his pomp, enjoy almost rock star status and huge amounts of money can follow them around’

Some, like Neil Woodford in his pomp, enjoy almost rock star status and huge amounts of money can follow them around; some managers are known as momentum investors – following rising trends in the expectation that they will continue, whilst others may be contrarian – purchasing unfashionable shares in pursuit of market beating performance.

The fund’s distribution yield is often used as an indicator of the income an investor may be able to expect from the fund in the next twelve months and is expressed as a percentage of the midpoint between a fund’s bid and offer prices on a particular day.

Historic yield is used to show the distributions declared over the previous 12 months, whereas underlying yield denotes annualised income after all expenses have been declared.

Past performance should be examined carefully by a would-be investor and there are plenty of data sources available to aid your research, including Morning Star and Trustnet.

The Investment Association classifies funds to allow objective comparison by industry sector, asset type or region in which they invest and also whether they seek to deliver income or growth.

The Cost of Investing in Unit Trusts

There are two main types of charges attached to unit trusts, one-off charges and regular or annual charges, all of which have to be disclosed before you invest.

One-off charges include the cost of entry – the ‘initial’ or ‘preliminary’ charge or, very rarely, an exit charge levied in its stead.

A fund’s ongoing charges – formerly known as the total expense ratio or ‘TER’ – pay for the running of the fund; some might even levy a performance fee which becomes due if the manager beats the fund’s set performance target.

‘Technology is the enabler and for those prepared to invest some time getting to grips with unit trusts, the benefits could be significant.’

The fund also pays out the trading commissions that are incurred by buying and selling assets.

When considering an investment you need to understand whether the past performance of the fund represents capital return or total return (a rising or falling share price and dividend income) and also whether that return is shown before or after taxes and charges, how its portfolio has performed relative to its benchmark and how it has performed relative to other funds in its sector.

The unit trust fact sheet gives you an indication of how the fund has performed, how transparent it is on costs and its underlying holdings is certainly up for debate.

On other parts of this site you will find fund managers explaining the strategy and objectives of the funds they manage and what was once an industry dominated by intermediaries, correctly schooled in what to look for, there is no reason why the DIY investor should not be able to achieve the market exposure they want, at a transparent cost and with a risk profile they can tolerate without the need to pay for expensive advice.

Technology is the enabler and for those prepared to invest some time getting to grips with unit trusts, the benefits could be significant.