What is a unit trust?

It is a collective investment, meaning that a number of people pool their money in a fund that then buys and sells shares, or bonds, on their behalf. The idea is that by pooling their money and investing in a range of shares or bonds, investors spread the risk. Some unit trusts are also known as open-ended investment companies (Oeics), but they operate in the same way as unit trusts.

How do they work?

The unit trust fund is divided into units, each of which represents a tiny share of the overall portfolio. Each day the portfolio is valued, which determines the value of the units. When the portfolio value rises, the price of the units increases. When the portfolio value goes down, the price of the units falls.

Who looks after it?

The unit trust is run by a fund manager, or a team of managers, who will make the investment decisions. Different fund groups have different ways of operating. Some allow individual fund managers free rein to run a fund in their own way. Others prefer a more team-based approach, where a collective ethos prevails.

How many unit trusts are there?

There are about 2,000 unit trusts in the UK. They invest in stock markets all round the world. Many are based in the UK, but there are large numbers investing in the major developed regions of the world, such as the US, Europe and Japan. There is also increasing interest in emerging markets, whether in Eastern Europe, the Far East or Latin America.

For the more adventurous investor, there are funds investing in individual emerging markets, such as China, or in the so-called Bric economies (Brazil, Russia, India and China).

There are funds investing in metals and natural resources, as well as many putting their money into bonds. Some offer a blend of equities, bonds, property and cash and are known as balanced funds. Investors who wish to marry their profits with their principles can put their money in an ethical fund.

Some funds invest not in shares directly but in a number of other funds. These are known as multi-manager funds.

Active versus passive

Most fund managers use their own judgment to assemble a portfolio of shares for their funds. These are known as actively managed funds.

However, a sizeable minority of funds simply aim to replicate a particular index, such as the FTSE all-share index. These are known as passive funds, or trackers.

There is a lively debate about the relative merits of active and passive funds, though passive funds definitely have lower charges.

Fund charges

A typical actively managed fund will have an initial charge of about 5 per cent and an annual charge of about 1.5 per cent. A tracker fund will usually charge little or nothing upfront and between 0.5 per cent and 1 per cent a year. Multi-manager funds tend to be among the most expensive, because they incorporate two levels of charges, one for the multi-manager itself and one for the underlying funds.

Performance

This can vary hugely between different investment sectors. For example, most US and Japan funds have barely broken even or have actually lost money over the past five years, while those investing in emerging markets have produced a five-year return averaging more than 70 per cent.

How do you buy unit trusts?

You can buy through your financial adviser, through a fund supermarket, a discount broker or by going direct to the fund group.

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