In the pool, but not too deep

With unit trusts you can share in the stock market's highs and ride out the lows.
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The Independent Online
INVESTORS holding Barings unit trusts had nothing to worry about when the bank crashed. Each trust's investments were held separately from the bank and any cash holdings were not on deposit with Barings.

Not only are unit holders in a good position if the company that manages their money goes bust but, due to the structure of trusts, they have added safeguards against any fraudulent activity. As the name suggests, a unit trust is set up under a "trust" structure where the trustee, which in most cases is a bank, holds the money and monitors the investment process to ensure there is no foul play by the manager. To date this system has proved a resounding success with not one case of fraud recorded against a unit trust manager.

Of course, these safeguards cannot make up for the risks involved in investing in equities. Victoria Nye, the director of communications at the Association of Unit Trust and Investment Funds (Autif), which represents most unit trust companies, says: "People who would have sleepless nights knowing that their money could fall [in value] at any time should not be investing in a unit trust or any other sort of equity investment.

"And those who are just looking for the same returns as they would get from a building society should stick with a building society. But for almost everybody else with money to save, unit trusts can play a very useful role."

Unit trusts were introduced 60 years ago as a way for individuals to get exposure to the stock market with less risk and expense than in investing in individual companies through a stockbroker. There are now more than 1,600 unit trusts to choose from run by 160 fund management companies.

Unit trusts are "pooled" investments - an investor's money is combined with that of other investors to create a fund of millions of pounds. The units investors buy each represent the trust's total portfolio in microcosm. The pooling of cash allows the management company, which makes the investments on the unit-holders' behalf, to invest in a far wider range of companies and spread the risk.

Unit trusts are easy to get in and out of, with no lock-in period and dealing allowed over the telephone - though check the charges as some investment groups levy an exit fee, particularly on Personal Equity Plans. With many trusts investors can either put in a lump sum of as little as pounds 500 or pounds 20 a month. The value of units in each trust is published daily in national newspapers.

Over the longer term, when the ups and downs of stock market investment are smoothed out, the returns on the typical unit trust are impressive when compared to those from a building society. An investment of pounds 1,000 10 years ago in the average UK balanced unit trust would now be worth pounds 3,400 (nearer pounds 4,000 in a PEP) compared with pounds 1,400 in a building society account.

It is relatively easy to make sense of, and compare, the costs of unit trusts. But one aspect of unit trust investment that continues to cause confusion is pricing. When someone invests in a unit trust, the units are generally purchased from the fund management company at a buying price, traditionally called the "offer" price, and sold back to the fund management company at a lower selling price - termed the "bid" price. The bid/offer "spread" is the difference between the two prices. It includes, but is bigger than, any quoted initial charge.

In addition most trusts are valued daily on either an historic or forward basis. If an investor buys or sells forward he is in effect dealing "blind" and will, for example, purchase at the buying price at the next point at which the fund is valued. Most trusts will have at least one valuation point daily and some may have more than one. Some trusts still deal on an historic basis, at prices calculated at the last valuation point.

But the UK is in the minority in having different buying and selling prices. Next year single-pricing is to be introduced with the launch of open-ended investment companies (Oeics), which will be an alternative to unit trusts but under a company structure and will bring the UK in line with the rest of Europe.

Unit trusts are predominantly a UK product and the investment industry has long been lobbying for the introduction of Oeics to help them compete with other European investment centres as well as giving them a simpler product to sell to UK investors. Oeics will be single-priced so that purchases and sales will take place at the same price. It is expected that many unit trusts will want to convert themselves into Oeics.

With so many funds to choose from, it is vital to spend some time thinking about what is required from an investment. Would-be investors should ask themselves a few straightforward questions.

q How long are you hoping to save for? Charges will eat disproportionately into investments held for shorter periods. Most companies will recommend that you keep a unit trust for at least five years.

q What do you want from your savings? There are several options to choose from, depending on whether you want a regular income, capital growth, or a mixture of the two.

q You have also to think about what sort of return you want from your investment. Some people will be looking to make as much money as they can. But with funds capable of delivering very high returns you must expect the value of your investment to fluctuate, often quite dramatically, at certain times. Those who want a more dependable investment can find trusts that will pay some regular income that in the longer term should beat that from the building society, and that will provide some capital growth as well. Those who are able to save for the longer-term can afford to take more risks and invest in the more exotic regions of the world. But for those less willing to take risks, or with a shorter time frame, it is best to stick to UK funds.

Many companies suggest that first-time investors, particularly PEP investors, should choose an income-producing unit trust, invested predominantly in equities and UK-based. Rachel Medill, at M&G, the UK's largest unit trust company, says: "They may not give the highest yield but that income will grow over the years. At least you get a tangible return every single year rather than just your capital fluctuating."

The past performance of a fund is important but it is best to look at the longer-term record of a fund management company or an individual unit trust. The best funds will show good performance over all periods. For investors who already own some shares, it is worth finding out whether the management company has a share exchange scheme. People investing for income should also check how frequently income is paid and what the dividend is.

Lastly, consider the charges. Companies will levy an initial charge and an annual management fee. These can be as much as 6 per cent up-front and up to 1.5 per cent of the total value of the holdings as an annual charge, although for cash, bond and index-tracking funds and many Peps this figure is often lower.