Investment funds are collective investment vehicles, meaning people’s money is pooled together and invested by a fund manager into a basket of assets, such as shares.

There are four main types of funds available:

  • Unit Trusts
  • OEICs
  • Investment Trusts
  • Exchange-traded Funds (ETFs)

They can be active or passive, focus on specific asset classes, have varying objectives, investment risks associated or implement different strategies.

– they lower investment costs through economies of scale (the sharing of costs amongst others). For example if an individual invested into all of the shares that a fund invested into, it would be prohibitively expensive due to multiple trading charges

– they provide instant diversification for an investment portfolio reducing it’s risk. For example, an investment into a single company may do very well, but the company may also fail so all the money invested could be lost from just one investment

– they provide easy access to a range of markets, sectors and regions that would otherwise be very expensive to invest into, or even impossible to access at all

Passive Active

Passive Funds

Passive funds aim to mirror or track a particular benchmark, such as an index. They are generally cheaper than active funds, but do not provide the opportunity to beat the chosen benchmark.

Active Funds

Actively managed investment funds are those where a fund manager makes investment decisions with the goal of outperforming a particular benchmark, such as an index or the performance of their competitor funds. Although they tend to have the main goal of providing increased performance, they may also be less volatile (a measure of risk) than the benchmark they are trying to outperform.

They may be suitable for investors looking to make potentially higher returns than a fund that simply tracks an index, and/or wants access to more specialised areas (e.g. technology, healthcare or biotechnology).

They are generally more expensive than passive funds due to the fact they are being managed by a professional team.

Funds vary in the asset classes they invest into.  They may specialise in:

  • equities (i.e. shares in companies);
  • bonds (i.e. government or corporate debt);
  • property (e.g. physically owned property or shares in property companies);
  • commodities (e.g. gold or platinum);
  • alternative assets (e.g. agriculture, renewable energy or infrastructure); or
  • a combination of asset classes.

They can then specialise within the asset classes, for example by investing within a specific sector (e.g. healthcare), region (e.g. Europe) or company size (e.g. smaller companies).

They also vary in their objectives, such as producing capital growth, income, or a combination of the two (a balanced approach).

Unit Trusts and Open Ended Investment Companies (OEICs) are open-ended funds, meaning that the investment management company creates new units/shares when an investor wants to buy the fund, or cancels units/shares when an investor sells the fund. They are priced and traded once per day according to the value of the underlying investments.

What is the difference between a Unit Trust and an OEIC?

The differences lie predominantly in their structure and pricing.

A Unit Trust is set-up under a trust deed, issues units rather than shares, and has both a bid price (the price a seller receives) and an offer price (the price a buyer pays), with the difference between the two (called the bid-offer spread) reflecting unit creation costs.

An OEIC is set-up in a similar way to an ordinary company, issues shares rather than units, and has only one price at which to buy and sell.

Investment Trust

UK Investment Trusts are structured as companies (slightly misleading from the name) and are ‘closed-ended’ funds, meaning that the number of shares available is limited and their price is largely determined by the supply and demand for them. They are priced and traded via the London Stock Exchange. Because Investment Trust share prices are affected by supply and demand, their value can fluctuate more often and to a greater extent than open-ended funds; this is because the price can trade at either a premium (due to high demand) or discount (due to low demand) to the value of the underlying assets, the net asset value.

The net asset value (NAV) per share is equal to the total value of a trust’s assets minus its liabilities divided by the number of shares in issuance. When a trust’s share price is trading below its NAV per share then the trust is trading at a discount, and when trading above its NAV per share the trust is trading at a premium.

An Investment Trust has an independent board of directors who are responsible for looking after shareholders’ interests. They also have the ability to borrow money with which to invest; this is known as ‘gearing’ or ‘leverage’, which must be authorised by the Trust’s board of directors and declared to its investors.

The Investment Trust market is far older than that of Unit Trusts and OEICs, with the first Investment Trust (Foreign & Colonial) launched in 1868!


Exchange-traded funds (ETFs)

The FCA definition of an ETF is ‘An open-ended investment fund which tracks certain indexes and is bought and sold on an exchange rather than through a fund manager.’ Effectively an ETF is a hybrid of a pooled investment fund (in particular an index tracker) and a share. This is similar in context to an Investment Trust but instead of investing in a spread of assets and regions an ETF will be dedicated to a specific index such as the FTSE 100. Where the two differ is that an investment trust is a closed ended fund whereas the ETF is open. So essentially then the ETF is set up like a normal investment fund but whose shares for a retail client are listed on a ‘listed’ stock exchange and purchased via a stock broker.

Because of the general lack of active management they can give investors cheap and efficient access to a wide range of different indices, sectors and even commodities.

Units of an ETF can be purchased at any time (so long as the stock market is open) during the day (but a stockbroker does need to be used) as a result the price can change regularly based on this buying and selling, also as well as being held directly they can be held via a wrapper such as an ISA, SIPP, SSAS, offshore bond or child trust fund

It must be remembered that ETFs come in many different guises as they can use differing methods of tracking an index i.e.

Full index replication

The ETF will hold all the constituents of the index in the same proportion as the index.

Sampling replication

The ETF will hold a sample of the constituents of the index which it is replicating. This could mean the ETF does not fully replicate the index and may return more or less.

Synthetic replication

This involves the use of SWAPS and consequently there is a counter-party risk. The ETF buys investments that may not be within the index the ETF is tracking. It then swaps the return on these investments for the return on the index.

In addition to this there are more complex version which can involve high risk strategies such as gearing so that for every £100 put in the fund the fund will borrow additional monies so that more than original £100 is invest (i.e. the fund may borrow £100 so £200 in total is invested) this works well if the investment increases in value, as you would get nearly double the return (based on amount borrowed meaning £200 invested) but if it falls you loss twice as much and could lose all the investment.

As you can see the more complex the structure the higher the investment risk involved.