What to invest in after ISAs - Collective Investments

First of all…Happy New Year

Which product after an ISA and a deposit account?

There are lots to choose from!

Open-ended investment companies (OEICS), Unit Trusts, Undertakings in Collective Investments in Transferable Securities (UCITS), Unregulated Collective Investment Schemes (UCIS) and not to be confused with UCITS, Investment Bonds, Offshore Investment Bonds, Pensions of various sorts, Venture Capital Trusts(VCTs), Enterprise Investment Schemes (EIS), Seed Enterprise Investment Schemes (SEIS) to name but a few.

For now I am going to explain the basics of how most of them work. Pooling, Unit-linking and Collective investment are terms you may not hear very often but they help describe how most investment products are put together. They are part of the industry jargon that I want to demystify. Let’s start with collective investment.

If you wanted to invest a lump sum into a variety of assets, say shares, you would need to buy them through a stockbroker who will charge you for that service. You would receive share certificates for each share you bought and you would need to find somewhere to keep them safe. You would now have a portfolio of investments. If you want to know how much your portfolio is worth you would need to check each share price and multiply it by the number of shares you hold. When dividends are paid you will receive a cheque which you need to bank. You could use your dividends to buy more shares but you would need enough of them to meet the minimum deal for each share. You could use your dividends as an income and simply spend them. Tax will need to be accounted for on the dividends whether you spend them or reinvest them. When you want to sell some shares you need to retrieve the certificate or certificates and send them off. If you want to know how well you are doing against the market you can compare your portfolio’s growth against the relevant index.

You might already have concluded that it is messy and time-consuming.

You could use one of the many online stock-buying services. Online share buying services usually offer a facility to hold the share certificates for you and provide you with a statement about how much you have received in dividends each year. They also usually provide an online valuation telling you how much your portfolio is worth each day. The fees are often lower than using a traditional stockbroker (often called a wealth manager these days although the term is used to describe a wide range of financial services firms from insurance companies to financial advisers).

You would still have the problem of deciding which stocks to buy and when to sell them. You would need to spend time researching the markets and the companies themselves. You would need to rebalance your portfolio – this is required when one or more stocks out-perform and end up as a larger percentage of the portfolio. This leads to your portfolio being un-balanced and increases your investment risk. The same problem occurs in reverse when stocks under-perform. To overcome this, a portfolio needs to be regularly rebalanced. And after all that… research shows you will almost certainly underperform the professional fund managers. (Although I was reminded once that it was amateurs that built the Ark and professionals who built the Titanic).

To overcome all the admin headaches and have someone to make the investment decisions is where collective investments come in. Collective investments are where many people put together their money in an investment fund. This is called “pooling”. By doing this they reduce costs and reduce risk by being able to diversify over a wider range of holdings.

One of the oldest forms of collective investments is the Unit Trust have been around for over eighty years. A trust is set up which holds the share certificates for you and all the other investors. The trust means your investment is kept legally separate from the investment company which is managing the portfolio so that you are not investing in the company itself. The trust is overseen by trustees who are not the investment management company. The trustees are there to govern the proper running of the trust. The fund manager of the investment company then makes the investment decisions, takes care of rebalancing the portfolio, buys and sells shares and so on. In order to work out the value of your share of the investment fund, you are allocated units which express how much of the fund you own. When the investments in the fund go up and down the value of your units goes up and down to reflect the increase or decrease. To work out the value of your holding you simply multiply the unit price by the number of units you hold. This is what is meant by unit-linked investments – your “investment” is linked to a “unit”.

When new investors come along new units are created and when investors sell the units are cancelled.

PSS Unit Trust

Company Number of shares held Price £ Value £

BP 100 4.25 425

Vodafone 50 3.00 150

RBS 100 2.50 250

Total 825

Say 100 units of £8.25 each

One week later…

PSS Unit Trust

Company Number of shares held Price £ Value £

BP 100 4.75 475

Vodafone 50 3.50 175

RBS 100 2.00 200

Total 850

100 units of £8.50 each

There are two types of units which may be available – income and accumulation. Income units as the name suggests pay out to you any income that is received, usually twice a year to avoid making regular payments of very small amounts. Accumulation units reinvest the income and dividends to increase the unit price. You do not receive the income but benefit from a higher valuation of the same amount. However – it is income and you need to pay tax on it. I have met more than one adviser who did not understand this point! You will receive a statement from the manager and it will contain details of the income paid back into your fund and how much tax has been deducted at source, if any. You need to enter this on your tax return.

Unit Trusts are now largely superseded by Open Ended Investment Companies (OEICS). They are similar in almost every respect except that in place of a trust there is a company. Instead of buying units in a trust you buy shares in the company. In order for your investments to be kept separate from those of the investment manager a Depositary is used. A depositary is usually a bank and it holds the share certificates and so on. As with a unit trust, when new investors come along more shares are issued and when they sell the shares are cancelled. This leads to this type of investment fund being called an “investment Company with Variable Capital” or ICVC. The terms OEIC and ICVC are interchangeable. Later in the series I’ll explain how “Closed-Ended Investment Companies” work.

Remember if you like what you hear, tell your friends, family and colleagues. If not tell me – at the brand new but soon to be improved, website at www.poundsshillingsandsense.com

Till next time, thanks for listening.