The simple reason is that collective investments are less risky than direct investment in shares. This, in itself, makes them more attractive to cautious investors.
Additionally, because the funds are run by professional fund managers, they allow individuals with little cash to get access to the kind of investment expertise which they wouldn't normally be able to afford.
Today, there are three different types of collective investment: unit trusts, investment trusts and open-ended investment companies - more commonly known as Oeics. They all offer the chance to spread the inherent risks involved in the stock market by investing in a sizeable bundle of different companies' shares, rather than just one.
All these collective investments reduce the risk by pooling several investors' cash to create large sums that can then be invested in a range of different shares. Then if one share drops in price it should have a limited effect on the rest of the portfolio, so that the overall value of the fund remains pretty solid.
Unit trusts, investment trusts and Oeics are slightly different types of collective investment, each with its own advantages.
A unit trust is a fund split into equal units which can be bought and sold. The price of a unit fluctuates as it is directly linked to the value of the fund; if the fund is performing well, the unit price will be higher, and vice versa. The more investors there are in a unit trust, the more units can be created.
There are 22 categories of unit trust with around 1,700 funds. "It's the easiest way to invest in the stock market, especially if you're new to the equities game," says Emma Weiss of the Association of Unit Trusts and Investment Funds (Autif). "It's convenient, and cost-effective, and leaves the investment decisions to the professionals, who have the time and expertise to make your money work for you."
An investment trust is a company in which anyone can buy and sell shares. The cash raised from the sale of shares is in effect used to invest in other companies. There are now 335 investment trust companies in the UK grouped in 24 different sectors but growth seekers have their own UK and international sectors.
However, unlike unit trusts, investment trust share prices are not directly linked to the underlying performance of the investment portfolio. As with any equity, supply and demand will have a large influence on the share price as will the overall stock market sentiment; although, if the investment trust is performing well that will obviously be reflected in the popularity of its shares.
"Generally, investment trusts have a far better record of growth than any other collective form of investment over the long term and they have the advantage of low management charges," says Andrew Barker, chairman of the Association of Investment Trust Companies (AITC). "They are also quoted on the stock market, which means you can easily buy and sell their shares."
The Oeic only arrived on the UK investment scene last year and is a cross between its two older cousins. Oeics offer shares like investment trusts but are open-ended like unit trusts. This means that they can alter the number of shares they issue to match demand.
Consequently, their share price is based directly on the value of the fund, rather than bending with market sentiment as can happen with investment trusts.
Oeics are seen as the future of collective investment as they are reckoned to be more flexible and simpler to understand than either of their rival types of collective funds. However, few investment houses have taken up the Oeic challenge to date.
Not all unit trusts, investment trusts and Oeics are allowed to be put into a personal equity plan to get tax advantages. Qualifying trusts must have at least 50 per cent of their funds invested in UK or EU quoted shares, bonds or convertibles. If you pick a non-qualifying trust, which must be invested in a stock market recognised by the Inland Revenue, you'll only be able to invest up to pounds 1,500 in a PEP, rather than the pounds 6,000 in a qualifying fund.
Contact Autif (0171-831 0898) for more information about investing in unit trusts and Oeics and the AITC (0171-431 5222) for information about investment trust companies.Reuse content