Equity funds

Equity funds are ideally suited to investors who don’t have the time or skill to manage their stock market investments directly. With thousands of funds to choose from, investors should be confident they are diving into the right investment pool.

What are equity funds?
Equity funds, or collective funds, pool the money of numerous individual investors to create a portfolio with a specific investment objective – income, growth, or a blend of the two.

What are the advantages of buying a fund over buying shares myself?
The main benefit is that you use the leverage of the fund to get exposure to a wider range of assets than you could with a small direct investment. Spreading your investments also means reducing the risk of losses. The other perk is reduced dealing costs. If you were buying direct, you would shoulder upfront charges, including trading costs, which can erode returns on a small portfolio. Pooled funds can negotiate discounts on dealing costs because of their size.

And the disadvantages?
You will often pay big bucks for the fund manager with fees ranging from about 5 per cent for the annual management fees as well as initial charges. As an indirect investor, you will need to be totally confident in your fund manager’s judgment as you won’t have any say over where your money is invested. You will also lose any rights connected with direct investment in a stock, including the right to attend the company’s annual general meeting or benefit from shareholder perks.

What can these funds invest in?
They can invest in a range of assets including cash and fixed interest, property as well as shares of other companies. But the precise asset blend will depend on what the fund is trying to achieve: income or growth. Some funds will not invest in certain sectors, such as defence companies, for ethical reasons. Others might focus on niche areas, such as emerging markets or US small companies.

What kinds of funds are there?
The most common are unit trusts, investment trusts, open-ended investment companies (Oeics) and exchange traded funds (ETFs).

How are they different?
Many investors take their first dip into a pooled fund by buying into a unit trust. Unit trusts are a fairly uncomplicated concept in that they are run by a Trust, which is the registered holder of the fund’s underlying assets. When you invest in a unit trust you are issued with units. These units are not traded on a stock exchange but are bought and sold by the fund’s managers. The trust is also “open-ended” which is industry jargon for saying that the fund has no limit on the number of units it can issue. This means the size of the fund will fluctuate as unit-holders buy and sell. The price of the unit is based on the value of the investments the trust has invested in.

What about Oeics?
Oeics (pronounced oiks) are similar in structure to unit trusts as they are open-ended. However, Oeics are set up as a company rather than a trust, and investors buy shares in the company.

Oeic shares are not tradeable on a stock exchange but are bought and sold from the fund managers. The value of Oeic shares varies according to the value of the fund, which is determined by the investments the fund manger makes. Another big difference between Oeics and unit trusts is pricing, with Oeic shares being single rather than dual-priced. This means that there is one price for buyers and sellers alike, and no spread between bid and offer prices. Some see this charging structure as more transparent and fair on investors. Some of the biggest funds in the UK are Oeics, including Fidelity’s Special Situations, run by Anthony Bolton, and Invesco’s High Income fund run by Neil Woodford.

And investment trusts?
Investment trusts are listed companies that invest in the shares of other companies. They are different from Oiecs and unit trusts in several ways. As listed companies they must have an independent board of directors and are answerable to shareholders. Unlike unit trusts and Oiecs, they are considered closed-ended as they have a fixed number of shares to issue. Investment trusts can also borrow money, or gear up, to make additional investments. Certain investment trusts issue different classes of shares to meet different investors’ needs. These different classes of share have varying rights and entitlements within the trust. There are more than 300 investment trusts in the UK.

Exchange Traded Funds (ETFS) are like a hybrid of a share and pooled index fund in that they offer the diversity of a fund but trade like stocks. Investors buy shares in the ETF which are quoted on the stock exchange. However, unlike other pooled investments, ETFs don’t invest in other company’s shares but track the performance of indices, such as the FTSE 100. With typical management fees as low as 0.5 per cent a year or less, ETFs often appeal to those wanting a low-cost entry into a pooled fund.

What do I need to know before I buy?
It is important to check all the charges on the funds, including initial and annual management fees, as these can have a major impact on your returns. Also, be certain of what the fund invests in as risk varies greatly between funds. Check if the fund can be bought through an Isa wrapper as this could spare paying tax on any gains.